Big Deal,Inc.wants to grow 30% next year.If it maintains its 40% dividend payout ratio,liabilities to equity ratio of 1,and total asset turnover of 2,what must its profit margin be to achieve this growth?

Question

Quizplus · Accepted Answer

To achieve a 30% growth rate with a 40% dividend payout ratio, the company needs to retain 60% of its earnings (100% - 40%). The sustainable growth rate formula is: Sustainable Growth Rate = ROE * Retention Ratio. Given that the liabilities to equity ratio is 1, the company's equity multiplier is 2 (1 + 1). With a total asset turnover of 2, and assuming all profits are reinvested, the ROE can be calculated as follows: ROE = Profit Margin * Total Asset Turnover * Equity Multiplier. To find the profit margin necessary to achieve a 30% growth rate, we rearrange the sustainable growth rate formula to solve for the profit margin, resulting in a profit margin of 9.6%.