Question

Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, a before-tax cost of debt of 12%, 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 $3, and the current stock price is $29.

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 $1.6 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

a)
WACC = (weight of debt * costof debt * (1 -t)) + (weight of equity * cost of equity)
14% = (55% * 12% * (1 - 0.25)) + (45% * cost of equity)
14% = 4.95% + (45% * cost of equity)

Cost of equity = (14% - 4.95%) / 45% = 20.11%

Growth rate = Ke - (D1 / P0)
= 20.11% - ($3 / $29)
= 20.11% - 10.34%
= 9.77%

Expected growth rate = 9.77%

b)
Equity = Asset * weight of equity = $8 billion * 45% = $3.6 billion

ROE = Net income / Equity
= $1.6 billion / $3.6 billion
= 44.44%

Growth rate = (1 - payout ratio) * ROE
9.77% = (1 - payout ratio) * 44.44%

Payout ratio = 1 - (9.77% / 44.44%)
= 1 - 0.2197
= 78.03%

Payout ratio = 78.03%