Kahn Inc. has a target capital structure of 55% common equity and 45% debt to fu
ID: 2787707 • Letter: K
Question
Kahn Inc. has a target capital structure of 55% common equity and 45% debt to fund its $10 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 13%, a before-tax cost of debt of 12%, 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 $29.
a. )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.
%
b.) If the firm's net income is expected to be $1.6 billion, what portion of its net income is the firm expected to pay out as dividends?
Growth rate = (1 - Payout ratio)ROE
Explanation / Answer
a)
WACC = weight of equity * cost of equity + weight of debt * cost of debt
=>
13% = 0.55 * cost of equity + 0.45 * 12% * (1-0.4)
=>
cost of equity = 17.75%
Po = D1/(r-g)
=>
29 = 3/(17.75% -g)
=>
growth rate g = 7.41%
b)
7.41% = (1-payout ratio) * 17.75%
=>
payout ratio = 58.25%
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