Question

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You are given the following information for Clapton Guitars, Inc. Profit margin 10 % Total asset...

You are given the following information for Clapton Guitars, Inc.

Profit margin	10	%
Total asset turnover	1.4
Total debt ratio	0.49
Payout ratio	36	%

Calculate the sustainable growth rate (in %) (round 4 decimal places)

Expert Solution

Answer: We should begin by calculating the D/E ratio. We calculate the D/E ratio as follows:

Total debt ratio = .49 = TD / TA

Inverting both sides we get:

1 / .49 = TA / TD

Next, we need to recognize that

TA / TD = 1 + TE / TD

Substituting this into the previous equation, we get:

1 / .49 = 1 + TE /TD

Subtract 1 (one) from both sides and inverting again, we get:

D/E = 1 / [(1 / .49) – 1]

D/E = 0.9607843

With the D/E ratio, we can calculate the EM and solve for ROE using the DuPont identity:

ROE = (PM)(TAT)(EM)

ROE = (.10)(1.4)(1 + 0.9607843)

ROE = .2745 or 27.45%

Now we can calculate the retention ratio as:

b = 1 – .36

b = .64

Finally, putting all the numbers we have calculated into the sustainable growth rate equation, we get: Sustainable growth rate = (ROE × b) / [1 – (ROE × b)]

Sustainable growth rate = [.2745(.64)] / [1 – .2745 (.64)]

Sustainable growth rate = .2131 or 21.31%

jeff jeffy answered 1 year ago

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