Kahn Inc. has a target capital structure of 50% common equity and 50% debt to fu

Question

Kahn Inc. has a target capital structure of 50% common equity and 50% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, 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 $2 and the current stock price is $27.

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 $1.5 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.

Explanation / Answer

WACC = 14%

before-tax cost of debt = 11%

WACC = Cost of debt * Weight of debt + Cost of equity * weight of equity

14 % = 6.6 * 0.5 + X * 0.5

Cost of equity = 21.4 %

Cost of equity = D1/P0 + g

.214 = 2/27 + g

g = 14 %

B) Growth rate = (1 - payout ratio) * ROE

.14 = ( 1 - X) * 0.30

Payout ratio = 53.33

ROE = net income / shareholders equity

= 1.5 b / 5b

= 0.30

Portion of net income that firm expected to pay out as dividends = 53.33 *1.5billion = .80billion

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