Question

Kahn Inc. has a target capital structure of 65% common equity and 35% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 15%, a before-tax cost of debt of 8%, and a tax rate of 25%. The company's retained earnings are adequate to provide the common equity portion of its capital budget. Its expected dividend next year (D₁) is $4, and the current stock price is $34.

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

   =____%

2. If the firm's net income is expected to be $2.0 billion, what portion of its net income is the firm expected to pay out as dividends? Do not round intermediate calculations. Round your answer to two decimal places. (Hint: Refer to Equation below.)

   Growth rate = (1 - Payout ratio)ROE

     =____%

Answer 1

Answer a)

WACC = (Cost of Equity * Weight of Equity) + (Cost of Debt after tax * Weight of Debt)

15% = Cost of Equity * 0.65 + 8% * (1-0.25) * 0.35

15% = Cost of Equity * 0.65 + 2.1%

Cost of Equity = (15% - 2.10%) / 0.65

Cost of Equity = 19.85%

Value of Stock =

34 = 4 / 0.1985 - G

34*0.1985 - 34* G = 4

6.749 - 34* G = 4

G = (6.749 - 4) / 34

G = 8.09%

Answer b)

ROE = Net Income / Shareholders' Fund

= 2 / 65% * 9 billion

= 0.34 OR 34%

Grwoth Rate = (1-Payout Ratio) * ROE

8.09% = (1- Payout Ratio) * 34%

1- Payout Ratio = 8.09% / 34%

1- Payout Ratio = 0.23794117647

Payout Ratio = 1- 0.23794117647

Payout Ratio = 76.21%

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