Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fu
ID: 2669052 • Letter: K
Question
Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, 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.
a. What is the company's expected growth rate? Round your answer to two decimal places at the end of the calculations.
_______ %
b. 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: Use Equation 10-9.)
Round your answer to two decimal places at the end of the calculations.
_________ %
Explanation / Answer
Target Capital structure:
Common equity = 60%
Debt = 40%
Operating Assets = $8,000,000,000
WACC = 14%
Before-tax cost of debt = 10%
Tax rate = 40%
Next year dividend (D1) = $2
Current stock price (P0) = $21
(a) Calculating Company’s expected growth rate:
14% = [(0.60 * Cost of equity) + (0.40 * 0.10 (1-0.40)]
0.14 = [(0.60 * Cost of equity) + (0.40 * 0.06)]
0.14 = [(0.60 * Cost of equity) + 0.024]
0.14 = [(0.60 * Cost of equity) + 0.024]
0.14 – 0.024 = [0.60 * Cost of equity]
0.116 = 0.60 * Cost of equity
0.60 * Cost of equity = 0.116
Cost of equity = 0.116 / 0.60
Cost of equity = 0.1933 (or) 19.33%
P0 = [D1 / (R – g)]
P0 = [$2 / (0.1933 – g)]
$21 = [$2 / (0.1933 – g)]
$21 (0.1933 – g) = $2
$4.0593 - $21g = $2
$4.0593 - $2 = $21g
$2.0593 = $21g
$21g = $2.0593
Dividend growth rate (g) = $2.0593 / $21
Dividend growth rate (g) = 0.09806 (or) 9.81%
Dividend growth rate (g) = 9.81%
(b)
Dividend payout ratio = [Dividends / Net income for the same period]
Dividend payout ratio = [Dividends / Net income for the same period]
Operating Assets = $8,000,000,000
Equity portion = [$8,000,000,000 * 0.60]
Equity portion = $4,800,000,000
Number of shares = [$4,800,000,000 / $21]
Number of shares = 228,571,428
Total dividend payment = 228,571,428 * $2
Total dividend payment = $457,142,856
Dividend payout ratio = [$457,142,856 / $1,300,000,000]
Dividend payout ratio = 0.35 (or)35%
Dividend payout ratio = 35%
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