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 16%, 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 $27.

What is the company's expected growth rate? Round your answer to two decimal places at the end of the calculations.

____%

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? (Hint: Refer to Equation below.)

Growth rate = (1 - Payout ratio)ROE

Round your answer to two decimal places at the end of the calculations.

____%

Answer 1

WACC = [WEIGHT OF EQUITY*COST OF EQUITY + WEIGHT OF DEBTS* AFTERTAX COST OF DEBTS]/ TOTAL WEIGHT

0.16 = [0.7*COST OF EQUITY+ 0.3*0.11]/1

0.16 = 0.7*COST OF EQUITY + 0.033

0.16-0.033 = 0.7*COST OF EQUITY

0.127 = 0.7*COST OF EQUITY

0.127/0.7 = COST OF EQUITY

0.18143 = COST OF EQUITY

COST OF EQUITY = 0.18143 = 18.143%

PRICE = D₁/K_e-g

27 = 3/0.18143-g

0.18143-g = 3/27 = 0.11111

0.18143-0.11111 = g

g = 0.18143-0.11111 = 0.07032 = 7.03%

COMPANY'S EXPECTED GROWTH RATE = 7.03%

FIRM'S NET INCOME = $1.6 bn

TAX = 40 % = 1.6*0.4 = 0.64 bn

AFTER TAX EARNINGS = 1.6- 0.64 = 0.96 bn = $ 960000

EQUITY CAPITAL= 0.7*8000000 = $ 5600000

ROE = AFTER TAX EARNINGS/ EQUITY CAPITAL = 960000/5600000 = 0.17143 = 17.14%

Growth rate = (1 - Payout ratio)ROE

0.0703 = (1 - Payout ratio)*0.1714

0.0703/0.1714 = 1 - Payout ratio

0.4101 = 1 - Payout ratio

1 - Payout ratio = 0.4101

Payout ratio = 1-0.4101 = 0.5899 = 58.99 %

PAY OUT RATIO IS EQUIVALENT TO 59%