Question

Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $12 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 $26.

a. What is the company's expected growth rate?

b. If the firm's net income is expected to be $1.0 billion, what portion of its net income is the firm expected to pay out as dividends?

Answer 1

a) Calculation of the expected growth rate :-

WACC = Cost of debt before tax * weight of debt * (1 - tax rate) + cost of equity * Weight of equity

14% = 12% * 0.55 * ( 1 - 0.25) + Cost of equity * 0.45

14% = 4.95% + Cost of equity * 0.45

Cost of equity = (14% - 4.95%) / 0.45

Cost of equity = 20.1111%

Cost of equity = (D1 / Po) + g

D1 =expected dividend payment = $3

Po = market price per share = $ 26

g = growth rate

20.1111% = (3/26) + g

g = 0.201111 - 0.115385

g = 0.085726

g = 8.5726%

growth rate = 8.5726%

b) Calculation of the dividend payout :-

Growth rate =( Net income / common equity) * ( 1 - dividend payout ratio )

8.5726% = (1,000,000,000 / 12,000,000,000 * 45%) * ( 1 - dividend payout ratio)

1 - dividend payout ratio = 0.46292308

Dividend payout ratio = 0.53707692

Dividend payout ratio = 53.71%