Question

1)

You are given the following information on Kaleb's Welding Supply:

Profit margin			6.9	%
Capital intensity ratio			.78
Debt–equity ratio			.9
Net income		$	86,000
Dividends		$	16,800

Calculate the sustainable growth rate. 2) You are given the following information for Hendrix Guitars, Inc.   Profit margin 5.7 %   Total asset turnover   1.5   Total debt ratio .38   Payout ratio 35 %     Calculate the sustainable growth rate

Answer 1

1) Profit margin = net income / Sales

or, 0.069 = $86,000 / Sales

or, Sales = $1,246,376.81159

Capital intensity ratio = Total assets / Sales

or, Total assets = $1,246,376.81159 x 0.78 = $972,173.91304

Now, Debt - Equity ratio = Debt / Equity = 0.9

So, if debt is 0.9, and equity is 1, then total assets is 1.9 (0.9 + 1).

Equity = Total assets x 1 / 1.9 = $972,173.91304 / 1.9 = $511,670.480547

Return on Equity (ROE) = Net income / Equity = $86,000 / $511,670.480547 = 0.16807692307 or 16.807692307%

Dividend payout ratio = Dividend / net income = $16,800 / $86,000 = 0.1953488372

Retention ratio (b) = 1 - dividend payout = 1 - 0.1953488372 = 0.8046511628

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

or, SGR = (0.16807692307% x 0.8046511628) / [ 1 - (0.16807692307% x 0.8046511628) ] = 0.1563946140 or 15.64%

2) ROE = Net Income / Equity

or, ROE = (Net Income / Sales) x (Sales / Equity)

or, ROE = (Net Income / Sales) x (Sales / Total assets) x (Total assets / Equity)

or, ROE = Profit margin x Total asset turnover x 1 / (1 - total debt ratio) = 0.057 x 1.5 x 1 / (1 - 0.38) = 0.1379032258

Retention ratio (b) = 1 - payout ratio = 1 - 0.35 = 0.65

SGR = (ROE x b) / [ 1 - (ROE x b) ] = (0.1379032258% x 0.65) / [ 1 - (0.1379032258% x 0.65) ] = 0.098463038 or 9.85%