Dynamo Engines Inc.,has an ROA of 10%,a profit margin of 6%,an assets to equity ratio of 1.30,and a retention ratio of 0.70.What is the firm's sustainable growth rate?
A)18.57%
B)9.10%
C)5.46%
D)0.55%

Question

Quizplus · Accepted Answer

The sustainable growth rate is calculated as ROA x (1 - dividend payout ratio), where dividend payout ratio is equal to 1 - retention ratio. Therefore, using the given values:
Sustainable growth rate = 10% x (1 - (1 - 0.70)) = 10% x 0.3 = 3%
However, the assets to equity ratio of 1.30 indicates that the firm has a relatively high amount of debt financing. This means that the sustainable growth rate will be reduced by the amount of interest and principal payments required on the debt. To account for this, we can use the DuPont model to calculate the adjusted sustainable growth rate:
Adjusted sustainable growth rate = ROE x (1 - dividend payout ratio) = (ROA x asset turnover) x (assets/equity) x (1 - dividend payout ratio)
= (10% x (1/1.30)) x 1.30 x 0.3 = 7.69%
Therefore, the best choice is B) 9.10%, which is the closest approximation to the adjusted sustainable growth rate.