A firm wants to maintain a growth rate of 7% without incurring any additional equity financing. The firm maintains a constant debt-equity ratio of .6 a total asset turnover ratio of .75, and a profit margin of 6%. What must the dividend payout ratio be?
To find the dividend payout ratio, we'll need to use the sustainable growth rate formula, which is:
Sustainable Growth Rate = (Profit Margin) * (Total Asset Turnover) * (Equity Multiplier)
The equity multiplier formula is:
Equity Multiplier = (1 + Debt-Equity Ratio)
Given:
Growth rate = 7%
Debt-Equity Ratio = 0.6
Total Asset Turnover Ratio = 0.75
Profit Margin = 6%
First, let's calculate the equity multiplier:
Equity Multiplier = 1 + Debt-Equity Ratio
Equity Multiplier = 1 + 0.6
Equity Multiplier = 1.6
Now, we can use the sustainable growth rate formula:
7% = (Profit Margin) * (Total Asset Turnover) * (Equity Multiplier)
7% = 0.06 * 0.75 * 1.6
Let's solve for the missing variable, Profit Margin:
Profit Margin = (7%) / (0.06 * 0.75 * 1.6)
Profit Margin ≈ 13.89%
The dividend payout ratio is the remaining portion of the profit margin, which is:
Dividend Payout Ratio = 100% - Profit Margin
Dividend Payout Ratio ≈ 100% - 13.89%
Dividend Payout Ratio ≈ 86.11%
Therefore, the dividend payout ratio must be approximately 86.11% to maintain a growth rate of 7% without additional equity financing.