Frasier Cabinets wants to maintain a growth rate of 5 percent without incurring any additional equity financing. The firm maintains a constant debt-equity ratio of 0.55, a total asset turnover ratio of 1.30, and a profit margin of 9.0 percent. What must the dividend payout ratio be? HINT: Determine if the target growth rate is IGR/SGR. Next, use the formula to determine how much money (%) the firm can afford to payout to stockholders. You will also want to review the DuPont identity.
26.26 percent
38.87 percent
49.29 percent
61.13 percent
73.74 percent
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To determine the dividend payout ratio, we need to calculate the internal growth rate (IGR) and the sustainable growth rate (SGR).
The internal growth rate is given by the formula: IGR = ROA × retention ratio, where ROA is the return on assets and the retention ratio is the ratio of profits retained in the firm.
Given the profit margin of 9.0 percent and a total asset turnover ratio of 1.30, we can calculate the return on assets (ROA): ROA = profit margin × total asset turnover ratio = 0.09 × 1.30 = 0.117.
Next, we need to calculate the retention ratio. Since the firm wants to maintain a growth rate of 5 percent without any additional equity financing, the retention ratio can be calculated as: retention ratio = 1 - (new equity financing / total assets).
Since the firm wants to maintain a constant debt-equity ratio of 0.55 and no additional equity financing, the new equity financing will be 0.55 times the total assets of the firm. Therefore, the retention ratio is: retention ratio = 1 - (0.55 × total assets / total assets) = 1 - 0.55 = 0.45.
Now, we can calculate the internal growth rate: IGR = ROA × retention ratio = 0.117 × 0.45 = 0.0527 or 5.27 percent.
Next, we calculate the sustainable growth rate (SGR) using the DuPont identity formula: SGR = ROE × retention ratio, where ROE is the return on equity.
The return on equity is calculated as: ROE = ROA × equity multiplier.
The equity multiplier is calculated as: equity multiplier = total assets / total equity.
Given the debt-equity ratio of 0.55 and the total asset turnover ratio of 1.30, we can calculate the equity multiplier: equity multiplier = 1 / (1 - debt-equity ratio) = 1 / (1 - 0.55) = 1 / 0.45 = 2.222.
Now, we can calculate the return on equity: ROE = ROA × equity multiplier = 0.117 × 2.222 = 0.26.
Finally, we can calculate the sustainable growth rate: SGR = ROE × retention ratio = 0.26 × 0.45 = 0.117 or 11.7 percent.
Since the target growth rate is 5 percent, which is less than the sustainable growth rate (11.7 percent), the firm can achieve the target growth rate without any additional equity financing.
The dividend payout ratio can be calculated as: dividend payout ratio = 1 - retention ratio.
Therefore, the dividend payout ratio is: dividend payout ratio = 1 - 0.45 = 0.55 or 55 percent.
So the correct option is not listed in the answer choices provided.
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