Question 4.3: The Sandar Co. has a debt-equity ratio of .5, a profit margi...
The Sandar Co. has a debt-equity ratio of .5, a profit margin of 3 percent, a dividend payout ratio of 40 percent, and a capital intensity ratio of 1. What is its sustainable growth rate? If Sandar desired a 10 percent sustainable growth rate and planned to achieve this goal by improving profit margins, what would you think?
ROE is .03 × 1 × 1.5 = 4.5 percent. The retention ratio is 1 – .40 = .60. Sustainable growth is thus .045(.60)/[1 – .045(.60)] = 2.77 percent.
For the company to achieve a 10 percent growth rate, the profit margin will have to rise. To see this, assume that sustainable growth is equal to 10 percent and then solve for profit margin, PM:
.10 = PM(1.5)(.6)/[1 – PM(1.5)(.6)]
PM = .1/.99 = 10.1%
For the plan to succeed, the necessary increase in profit margin is substantial, from 3 percent to about 10 percent. This may not be feasible.