Question

g Gamgee Company wishes to maintain a growth rate of 12.8 percent per year, a debt-equity ratio of 1.4, and a dividend payout ratio of 40 percent. The ratio of total assets to sales is constant at .94. What profit margin must the firm achieve

Answer 1

The Profit margin that must be achieved is 12.74%.

Profit margin

First step

Return on equity= Growth rate /(1 + Growth rate) × Retention ratio

Return on equity=12.8% / (1 + 12.8%) × (100%-40%)

Return on equity= 0.128/(1 +0.128) × 0.60

Return on equity= 0.128/1.128 × 0.60

Return on equity= 0.128/0.6768×100

Return on equity= 18.91%

Second step

Now the profit margin is:

Profit margin= ROE / Asset turnover × Equity Multiplier

Profit margin= 18.91% / {(1/.94) × 1.4}

Profit margin= 0.1891 / 1.06 × 1.4

Profit margin= 12.74%

Inconclusion the Profit margin that must be achieved is 12.74%.

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