A firm has decided that its optimal capital structure is 100% equity financed. I
ID: 2749210 • Letter: A
Question
A firm has decided that its optimal capital structure is 100% equity financed. It perceives its optimal dividend policy to be a 35% payout ratio. Asset turnover is sales/assets = .6, the profit margin is 10%, and the firm has a target growth rate of 7%.
Calculate the sustainable growth rate. (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
If not, what should the asset turnover be to achieve its goals? (Do not round intermediate calculations. Round your answer to 3 decimal places.)
Instead, what would the profit margin need to be to achieve its goals? (Do not round intermediate calculations. Enter your answer as a percent rounded to 1 decimal place.)
A firm has decided that its optimal capital structure is 100% equity financed. It perceives its optimal dividend policy to be a 35% payout ratio. Asset turnover is sales/assets = .6, the profit margin is 10%, and the firm has a target growth rate of 7%.
Explanation / Answer
Answer (a-1)
Sustainable growth rate = 3.9%
Answer (a-2)
The firms target growth rate = 7% is not consistent with its other goals - NO
Answer (b)
Asset Turnover = 1.077
Answer (c)
Profit Margin = 17.9%
Capital Structure = 100% equity
Dividend payout ratio = 35%
Asset turnover ratio = Sales / Assets = 0.60
Profit margin = 10%
Target growth rate = 7%
Sustainable growth rate can be calculated as
Sustainable growth rate = Return on Equity * (1- Dividend payout ratio)
Since the firm is all equity firm Total Assets = Total Equity
Hence ROE is equal to ROA
Given profit margin = 10% and Asset turnover = 0.60
(Net Income / Sales) * (Sales / Total Assets) = 0.10 * 0.6 = 0.06 or 6%
Sustainable growth rate = ROA * (1- Dividend Pay out ratio)
Sustainable growth rate = 0.06 * (1-0.35) = 0.06 * 0.65 = 0.039 or 3.90%
Target growth rate = ROA * (1- Dividend Pay out ratio)
0.07 = ROA * (1-0.35)
0.07 = ROA * 0.65
ROA = 0.07/0.65 = 0.1076923
Given Profit Margin * Total Asset turnover = ROA
0.10 * Total Asset Turnover = 0.1076923
Total Asset Turnover = 0.1076923 / 0.10 = 1.076923 or 1.077 (rounded off)
Given Profit Margin * Total Asset turnover = ROA
Profit Margin * 0.60 = 0.1076923
Profit Margin = 0.1076923/0.6 = 0.179487 or 17.9% (rounded off)
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