Profit margin is 10%, asset turnover is 1.5 times, financial leverage is 2.0 times, earnings per...

Profit margin is 10%, asset turnover is 1.5 times, financial leverage is 2.0 times, earnings per share are $2.00 and dividends per share are $2.50. Which of the following statements is correct:

1. The return on assets is greater than the return on equity

2. The return on equity is greater than the sustainable growth rate

3. The sustainable growth rate is greater than the return on assets

4. The stock is over valued

Expert Solution

We would calculate return on assets, return on equity and sustainable growth rate to determine which statement is correct

Return on assets	Profit margin*Asset turnover
Return on assets	10%*1.5
Return on assets	15.00%

Return on equity	Profit marginAsset turnoverFinancial leverage
Return on equity	10%1.52
Return on equity	30.00%

Sustainable growth rate	Retention ratio*Return on equity

Retention ratio	1-Payout ratio
Retention ratio	1-(2.50/2)
Retention ratio	1-1.25
Retention ratio	-25.00%

Sustainable growth rate	-25%*30%
Sustainable growth rate	-7.5%

Statement (1) and (2) are incorrect as return on assets is lower than return on equity and sustainable growth rate is lower than return on assets
Return on equity is greater than sustainable growth rate and thus statement (2) is correct

Thus, statement (2) is correct

jeff jeffy answered 1 year ago

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