Question

Ramble On Co. wishes to maintain a growth rate of 7 percent a year, a debt-equity ratio of 0.31, and a dividend payout ratio of 66 percent. The ratio of total assets to sales is constant at 1.27. What profit margin must the firm achieve?

Answer 1

growth rate = (1 - Dividend payout ratio) * Return on Equity(ROE)

7% = (1 -  66%) * Return on Equity(ROE)

Return on Equity(ROE) = 20.59%

Return on Equity(ROE) = Profit margin * (Sales / Total Assets) * (Total Assets / Equity)

Equity Multiplier i.e. (Total Assets / Equity) = 1 + Debt / Equity

Return on Equity(ROE) = Profit margin * (Sales / Total Assets) * (1 + Debt / Equity)

20.59% = Profit margin * (1 / 1.27) * (1 + 0.31)

Profit margin = (20.59% * 1.27) / 1.31

Profit margin = 19.96%