123 Inc has a profit margin of 15%. Its total asset turnover ratio is 2 and its dividend payout ratio is 60%. What is the company's internal growth rate?
Please show steps
To calculate the internal growth rate, we need to use the formula:
Internal Growth Rate = (Profit Margin x Retention Ratio) / (1 - (Profit Margin x Retention Ratio) x Asset Turnover Ratio)
1. Calculate the retention ratio:
The retention ratio is equal to 1 - dividend payout ratio. So, in this case, the retention ratio is 1 - 0.60 = 0.40.
2. Substitute the given values into the formula:
Profit Margin = 15% = 0.15
Retention Ratio = 0.40
Asset Turnover Ratio = 2
Internal Growth Rate = (0.15 x 0.40) / (1 - (0.15 x 0.40) x 2)
3. Simplify the equation:
Internal Growth Rate = 0.06 / (1 - 0.12)
4. Calculate the denominator:
1 - 0.12 = 0.88
5. Substitute the values into the equation:
Internal Growth Rate = 0.06 / 0.88
6. Simplify the equation:
Internal Growth Rate ≈ 0.0682 or 6.82%
Therefore, the company's internal growth rate is approximately 6.82%.
The internal growth rate can be calculated using the following formula:
Internal Growth Rate = (1 - Dividend Payout Ratio) * Return on Assets
1. Calculate the return on assets (ROA) using the profit margin and total asset turnover ratio:
ROA = Profit Margin * Total Asset Turnover Ratio
= 0.15 * 2
= 0.30
2. Insert the values into the formula for the internal growth rate:
Internal Growth Rate = (1 - 0.60) * 0.30
= 0.40 * 0.30
= 0.12
Therefore, the company's internal growth rate is 12%.
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