Question

Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 12%, a before-tax cost of debt of 9%, 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 $23. 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. If the firm's net income is expected to be $1.3 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

What is the company's expected growth rate?

The weighted average cost of capital (WACC) is the cost of raising capital, with the weights representing the proportion of each source of financing.

WACC = wd * rd (1 - t) + we*re                

Where,

WACC = 12%

Where Total asset of the company = Total Debt (D) + Total Equity (E) = $10 billion

wd is the proportion of debt of the company = D/ (D+E) = 45%

rd is the cost of debt = 9%

Tax rate t = 40%

we is the proportion of equity of the company = E/ (D+E) = 55%

re is the cost of equity= ?

Therefore,

12% = (1-40%)*9%*45% + Re*55%

→ Re = 17.40%

Now company's expected growth rate can be calculated with the help of following formula

P0 = D1/ (re –g)

Where

Stock Price P0 = $23 per share

Dividend paid after one year D1 = $3

Constant Dividend growth rate g =?

Cost of equity or required rate of return re =17.40%

Therefore

Stock Price = $23 = $3/ (17.40% - g)

→ g = 4.36%

If the firm's net income is expected to be $1.3 billion, what portion of its net income is the firm expected to pay out as dividends?

Total equity of the company = $10 billion * 55% = $5.5 billion

Total number of shares outstanding = Total equity / share price

= $5.5 billion / $23 per share = 239,130,435 shares

Expected dividend next year is $3, means each share is expected to get $3

Therefore total dividend paid out = 239,130,435 * $3 = $717,391,304.3

Portion of net income to be paid out as dividend = $717,391,304.3 /$1.3 billion = 55.18%