Question

Kahn Inc. has a target capital structure of 70% common equity and 30% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, a before-tax cost of debt of 11%, 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 $3, and the current stock price is $28.

1. 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.
   ____%
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? (Hint: Refer to Equation below.)
   Growth rate = (1 - Payout ratio)ROE
   Round your answer to two decimal places at the end of the calculations. Do not round your intermediate calculations.
   _______%

Answer 1

Solution:

Calculation of company's expected growth rate:

Firstly,we have to find out cost of equity(k)

we know that,WACC=Cost of equity*%equity+Cost of Debt*%debt(1-tax rate)

Therefore

0.14=k*0.70+0.11*30%(1-.40)

0.14=k*.70+0.0198

k=.1202/.70

=17.17%

Now for calculation of growth rate

P=D/(R-G)

Where,

P=current price of stock

D=Next year dividend

R=Company cost of equity

G=growth rate

Therefore

$28=$3/(0.1717-G)

.1717-G=b4$3/28

G=.1717-.1071

=.0646

=6.46%

b)Calculation of Payout ratio:

Shareholder's Equity=$8bn*70%

=5.6bn

Therefore,ROE=1.2bn/5.6bn

=21.42857%

Growth rate=(1-payout ratio)ROE

6.46%=(1-Payout ratio)21.42857%

Payout ratio=1-.3015

=.69853

=69.85%