Question

Kahn Inc. has a target capital structure of 55% common equity and 45% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 15%, a before-tax cost of debt of 10%, 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 $21.

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. 
   
3. If the firm's net income is expected to be $1.4 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

a. WACC = Weight of Equity * Cost of Equity + Weight of Debt * Cost of Debt *(1-Tax rate)
15% = 55% * Cost of Equity + 45%*10%*(1-40%)
55%* Cost of Equity = 15% - 45%*10%*(1-40%)
Cost of equity = 12.3%/55% = 22.36%

Growth Rate = Required rate - Dividend /Price = 22.36% -2/21 = 12.3862% or 12.39%

b. Growth = (1- Payout Ratio)*ROE
Payout Ratio = 1 - Growth/ROE
Payout ratio = Dividend/Net income = 1 - 12.3862%/22.36% = 0.4260 or 42.60%
Dividend = 0.4260 * 1,400,000,000 = 596,433,604.34

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