Question

High Flyer, Inc., wishes to maintain a growth rate of 14.5 percent per year and a debt-equity ratio of .6. The profit margin is 4.4 percent, and total asset turnover is constant at 1.14.
a.	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.)
b.	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.)

Answer 1

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 =(0.044)(1.14)(1 + 0.60)

ROE = 0.080256 or 8.03%

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

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

0.145 = [0.080256(b)] / [1 - 0.080256(b)]

b = 1.57792008803

So, the payout ratio is:

Pauout ratio = 1 - b

Payout ratio = 1 - 1.57792008803

Payout ratio = -0.5779 or -57.79%

This is a negative dividend payout ratio of 57.79%, 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 = [0.080256(1)] / [1 - 0.080256(1)]

Sustainable growth rate = 0.0873 or 8.73%