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 8%, 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 $30.

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

b. 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? Round your answer to two decimal places at the end of the calculations. Do not round your intermediate calculations.

Answer 1

Part A) Weight in equity = 45%

Weight in Debt fund = 55%

WACC = 14%

Before tax cost of debt = 8%

Tax rate= 40%

Calculating after tax cost of debt = 8% (1-.40) = 4.8%

Given WACC, calculating cost of equity i.e. Ke

14% = 0.45 ke + .55 x 4.8%

14% = 0.45ke + 2.64%

ke = 25.244%

Now, calculating growth rate

Po = D1 / (ke-g)

30 = 2/ (25.244%- g)

(30x 25.244% - 2 )/30= g

g = 18.57% (rounded off to two decimal places)

Therefore company's expected growth rate is 18.57%

Part B)

Payout Ratio

Growth rate = Return on equity x (1- payout ratio)

18.57% = 25.244% (1- payout )

18.57% = 25.244% -25.244% payout

(25.244 - 18.57) / 25.244 = payout

Payout = 26.44%

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