High Flyer, Inc., wishes to maintain a growth rate of 15.5 percent per year and

Question

High Flyer, Inc., wishes to maintain a growth rate of 15.5 percent per year and a debt–equity ratio of .8. The profit margin is 5 percent, and total asset turnover is constant at 1.1.
  
What is the dividend payout ratio? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Dividend payout ratio             %
  
What is the maximum sustainable growth rate for this company? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)
  
Sustainable growth rate             %

Explanation / Answer

First, we need the return on equity. Using the Du Pont identity, we find the return on equity is:

ROE = (Profit margin)(Total asset turnover)(Equity multiplier)

ROE =(0.05)(1.1)(1 + 0.80)

ROE = 0.099 or 9.9%

Now we can use the sustainable growth rate equation to find the retention ratio, which is:

Sustainable growth rate = [(ROE)(b)] / [ 1 - (ROE)(b)]

0.155 = [0.099(b)] / [1 - 0.099(b)]

0.155-0.015345b = 0.099(b)

b = 1.3555468

So, the payout ratio is:

Pauout ratio = 1 - b

Payout ratio = 1 - 1.3555468

Payout ratio = -35.55%

This is a negative dividend payout ratio of 40.04%, which is impossible; the growth rate is not consistent with the other constraints. The lowest possible payout rate is zero, which corresponds to a retention ratio of one, or total earnings retention. The maximum sustainable growth rate for this company is:

Sustainable growth rate = [(ROE)(b)] / [1 - (ROE)(b)]

Sustainable growth rate = [0.099(1)] / [1 - 0.099(1)]

Sustainable growth rate = 10.99%

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