A company has a retention rate of 50%, sales of $25,000, beginning equity of $50,000 and profit margins of 10%, an asset turnover ratio of .75 and debt of $10,000. What is its sustainable growth rate?

Question

A. 2.5%
B. 1.7%
C. 3.75%
D. Not enough information given

Answer 1

Answer: A. 2.5%

Calculation:
Sustainable growth rate is calculated as:

Sustainable growth rate = (1 - Retention rate)* ROE
We will have to calculate ROE in order to be able determine the sustainable growth rate:

ROE = Net Income / Shareholders equity

We are given profit margin of 10 %, we know profit margin is calculate as Income dividend by sales multiplied by 100 %

Profit margin =( Net income / Sales ) * 100
10 % = Net income / $ 25,000
Net income = $ 25,000 * 10 %
Net income = $ 2,500
We can now calculate ROE as:

ROE = ($ 2,500/ $ 50,000) * 100
ROE= 5 %

We calculate sustainable growth rate as:

Sustainable growth rate = ( 1 - 0.5 )* 5 %
Sustainable growth rate = 0.5 * 5 %
Sustainable growth rate = 2.5 %