Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fu
ID: 2787603 • Letter: K
Question
Kahn Inc. has a target capital structure of 60% common equity and 40% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 16%, a before-tax cost of debt of 8%, 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. Do not round your intermediate calculations.
%
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. Do not round your intermediate calculations.
%
Explanation / Answer
a)
WACC = weight of equity * cost of equity + weight of debt * cost of debt
=>
16% = 0.6 * cost of equity + 0.4 * 8% * (1-0.4)
=>
cost of equity = 23.47%
Po = D1/(r-g)
=>
27 = 3/(23.47% -g)
=>
growth rate g = 12.36%
b)
12.36% = (1-payout ratio) * 23.47%
=>
payout ratio = 47.34%
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