Question

Can a company achieve a sustained growth rate of 15 % given the following?  

Debt–equity ratio of 0.40 times
Profit margin is 5.3 percent
Capital Intensity Ratio is 0 .75 times
determine what the dividend payout ratio must be. How do you interpret the result?

Answer 1

Capital intensity ratio = Total Assets/ Total revenue = 0.75

Asset Turnover = Total revenue/ Total Assets = 1/0.75 = 1.33

Profit margin = 5.3%

Debt to Equity ratio = 0.40 times

Assets to Equity = Leverage = 1+ D/E = 1.4

ROE using Dupont = Asset turnover * Profit margin * Leverage = 1.33 * 5.3% * 1.4 = 9.89%

Also, Sustainable Growth rate = ROE * Retention ratio = ROE *(1-dividend payout ratio)

To have a Growth rate of 15%,

15% = 9.89%*(1-dividend payout ratio)

1.51= 1- dividend payout ratio

Dividend payout ratio = - 0.51 = -51%

This means that the firm has to take additional debt or equity of 51% of the Profits such that it is able to retain this earnings(retention ratio 151%) for future growth, so that ROE becomes 15%. This is possible only by selling equity to raise debt such that the Debt to Equity remains constant.