Question

You are given the following information for Hendrix Guitars, Inc. Profit margin 6.3 % Total asset turnover 1.75 Total debt ratio .35 Payout ratio 30 % Calculate the sustainable growth rate. (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Profit margin = Net income / Net Sales

Total asset turnover = Net Sales / Avg total assets

Total debt ratio = Total debt / Total asset

Payout ratio = Dividends / Net income

1. Calculate debt equity ratio (Total debt / Total equity)

Total debt ratio = Total debt / Total asset

Total asset = Total liabilities

Total liabilities = Total equity + Total debt

0.35 = Total debt / (Total equity + total debt)

Reversing both sides

1 / 0.35 = (Total equity + total debt)/ total debt

2.8571 = (Total equity / total debt) + 1

Total equity/ total debt = 1.8571

Reversing both side again,

Total debt / Total Equity = 1/ 1.8571

Debt equity ratio = 0.5385

2. We calculate equity multiplier i.e. Total asset / Total equity

We have calculated Debt equity ratio (Total debt / Total equity)

Adding one to debt equity ratio

(Total debt / Total equity) + 1 = 0.5385 +1

(Total debt + total equity) / Total equity = 1.5385

Equity multiplier = Total asset / Total equity = 1.5385

3. Calculate Return on Equity using DuPont formula for ROE

ROE = Profit margin * Total asset turnover * Equity multiplier

ROE = 0.063 * 1.75 * 1.5385

ROE = 16.9615%

4. Sustainable growth rate = (ROE * Retention ratio) / [1- (ROE * Retention ratio)]

Retention ratio = 1 - payout ratio = 1 - 0.30 = 0.70 or 70%

Sustainable growth rate = (16.9615% * 70%) / [1 - (16.9615% * 70%)]

= 11.8731 / 88.1269

= 13.47%