Question

Kahn Inc. has a target capital structure of 40% common equity and 60% debt to fund its $11 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 15%, 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 $4, and the current stock price is $32.

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 $1.9 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

Part A:

WACC is weighted Avg cost of sources in capital structure.

After tax cost of debt =Kd ( 1 - Tax rate )

= 12% * ( 1 - 0.25 )

= 12% * 0.75

= 9%

WACC:

Source	Weight	Cost	Wtd Cost
Equity	40%	X	0.40X
Debt	60%	9%	0.054
WACC	0.40X + 0.054

Thus 0.15 = 0.40X + 0.054

0.40X = 0.15 - 0.054

= 0.096

X = 0.24

Ke is 24%

Growth rate = Ke - [ D1 / P0 ]

= 24% - [ 4 / 32 ]

= 24% - 12.5%

= 11.5%

Part B:

g = b * r

b = retention ratio

r = ROE

b = g / r

= 11.5% / 24%

= 0.4792

Pyout Ratio = 1 - b

= 1 - 0.4792

= 0.5208

Div = Net Income * Payout ratio

= $ 1.9 B * 0.5208

= $ 0.9896 B

Pls do rate, if the answer is correct and comment, if any further assistance is required.