Question

Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 15%, a before-tax cost of debt of 11%, and a tax rate of 25%. 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 $30.

1. What is the company's expected growth rate? Do not round intermediate calculations. Round your answer to two decimal places.

   ______ %

2. If the firm's net income is expected to be $1.2 billion, what portion of its net income is the firm expected to pay out as dividends? Do not round intermediate calculations. Round your answer to two decimal places. (Hint: Refer to Equation below.)

   Growth rate = (1 - Payout ratio)ROE

   ______ %

Answer 1

WACC = wd*rd + we*re

Where,

wd = weight of debt

rd = Cost of debt

we = weight of equity

re = cost of equity

Cost of debt = Before tax cost( 1 - tax rate) = 11( 1 - 25%) = 8.25%

Now,

15% = 55% * 8.25% + 45% * re

15% = 4.54% + 45%re

15% - 4.54% = 45% re

10.46% = 45%re

re = 10.46 / 45%

re = 23.24%

a.) Now with cost of equity we will solve it by discounted cash flow approach

g = re - D1 / P0

g = growth rate

re = Cost of equity

D1 = Dividend

P0 = Price

g = 23.24% - 2 / 30

g = 23.24% - 6.67%

= 16.57%

b.) g = ROE( 1- Dividend payout ratio)

g = Net Income / Common Equity * 45% (1 - dividend payout ratio)

16.57% = 1200000000 / 10000000000 * 45% ( 1 - Dividend payout ratio)

16.57% = 1200000000 / 4500000000 ( 1 - dividend payout ratio)

16.57% = 26.67%( 1 - dividend payout ratio)

16.57% / 26.67% = 1 - dividend payout ratio

0.62129 = 1 - dividend payout ratio

Dividend payout ratio = 0.37871 or 37.87%