Question

Ramble On Co. wishes to maintain a growth rate of 11 percent per year, a debt-equity ratio of 1.3, and a dividend payout ratio of 35 percent. The ratio of total assets to sales is constant at .85.

What profit margin must the firm achieve? (Do not round intermediate calculations and enter your answer as a percent rounded to 2 decimal places, e.g., 32.16.)

Answer 1

Required:

Retention ratio (b) = (1 - Dividend payout ratio)

= (1 - 35%)

= 65%

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

11% = (ROE * 65%) / [1 - (ROE * 65%)]

0.11 * (1 - 0.65ROE) = 0.65 ROE

0.11 - 0.0715ROE = 0.65ROE

0.11 = 0.7215ROE

ROE = 0.11 / 0.7215

ROE = 15.25%

Now,

ROE = Net profit margin * Total assets turnover ratio * Equity multiplier

15.25% = Net profit margin * (Sales / Total assets) * (Total assets / Equity)

15.25% = Net profit margin * (1 / 0.85) * (D/E + 1)

15.25% = Net profit margin * (1 / 0.85) * (1.3 + 1)

15.25% = Net profit margin * (1 / 0.85) * 2.3

15.25% = Net profit margin * (2.3 / 0.85)

15.25% = Net profit margin * 2.70588

Net profit margin = 15.25 / 2.70588

Net profit margin = 5.64%

Thus, the profit margin must the firm achieve = 5.64%