Kahn Inc. (KI) is a distributor of intellectual property. Suppose that you are a
ID: 2617627 • Letter: K
Question
Kahn Inc. (KI) is a distributor of intellectual property. Suppose that you are a member of the financial analyst team at Franklin Templeton Investments (FTI) and have ascertained the following about KI as of June 15, 2018:
KI’s management desires to maintain a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets.
KI’s WACC is 13%;
KI has a before-tax cost of debt of 10%, and a corporate tax rate of 25%;
KI’s forecast net income is expected to be $1.1 billion;
KI’s retained earnings (aka, internally generated funds) are sufficient to cover all of the equity portion of its capital budget; that is, Ki will not need to issue new common stock for any upcoming capital expenditures (CAPEX);
KI’s expected dividend next year is $3 per common share;
KI’s current stock price is $35.
Define a corporation’s “sustainable growth rate” and its significance to that corporation’s “capital structure” and “capital budget”;
Calculate KI’s expected growth rate;
Determine the portion of KI’s income that it will be expected to pay out as dividends to shareholders if it adheres to its target debt : equity ratio.
Based on the financial information you have developed for this case scenario, forecast KI’s assets, liabilities, and shareholders’ equity for its next fiscal year ended June 15, 2019. Be sure to state assumptions and logic !
Explanation / Answer
sustainable growth rate = roe * (1 - div pay out) I.e roe * retention ratio
higherthe retention ratio higher the growth rate s.b.t roe
due to sgr company can generate fund for capex from it's internal accrual and need not to rely on borrowing hence it will result in less finance cost and higher margins .this how it can affect capital structure and budget.
in this case first we need to find ke
assume ke= x
x = 0.6 * x = 0.6x
0.4 * 7.5 =3
1. =13(wacc)
therefore x =0.6x + 3 = 13
x = 16.67
therefore growth rate = ke = d1/p0 + growth rate
= 16.67= 3/35+growth rate
growth rate. = 16.67-8.57
growth rate =8.10%
it's roe = 1.1/10 * 100 = 11%
therefore div payout = growth rate = roe * retention ratio
8.10. = 11 * retention ratio
retention ratio = 73.64%
therefore div payout = 26.36%
therefore for div amt = 1.1 billion * 26.36 %
=0.28996 billion $
calculations of asset liability and equity
assuming that net income is after interest
equity 6.81004 billion ( 6 + 0.81004 refer note 1) operating asset 10 billion
debt. 4 billion. cash balance. o.81004billion refer note 1
total 10.81004 billion. total. 10.81004 billion
note 1 :- retain earnings = 1.1- 0.28996 dividend = 0.81004 billion
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