Question

Kahn Inc. has a target capital structure of 50% common equity and 50% debt to fund its $12 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 15%, a before-tax cost of debt of 9%, and a tax rate of 40%. The company's retained earnings are adequate to provide the common equity portion of its capital budget. Its expected dividend next year (D1) is $2, and the current stock price is $28. What is the company's expected growth rate? Do not round intermediate calculations. Round your answer to two decimal places. % If the firm's net income is expected to be $2.0 billion, what portion of its net income is the firm expected to pay out as dividends? (Hint: Refer to Equation below.) Growth rate = (1 - Payout ratio)ROE Do not round intermediate calculations. Round your answer to two decimal places

Answer 1

a). WACC = [wD * before-tax kD * (1 - t)] + [wE * kE]

15% = [0.50 * 9% * (1 - 0.40)] + [0.50 * kE]

15% = 2.7% + [0.50 * kE]

0.50 * kE = 15% - 2.7%

kE = 12.3% / 0.5 = 24.6%

g = kE - [D1/P0]

= 0.246 - [$2/$28]

= 0.246 - 0.0714 = 0.1746, or 17.46%

b). Equity Value = Value of operating assets * wE

= $12 billion * 0.50 = $6 billion

ROE = Net Income / Equity Value = $2 billion / $6 billion = 0.3333, or 33.33%

g = (1 - payout ratio) * ROE

0.1746 = (1 - DPR) * 0.3333

1 - DPR = 0.1746 / 0.3333

DPR = 1 - 0.5237 = 0.4763, or 47.63%