WACC AND COST OF COMMON EQUITY Kahn Inc. has a target capital structure of 45% c
ID: 2826576 • Letter: W
Question
WACC AND COST OF COMMON EQUITY Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 12%, a before-tax cost of debt of 996, 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. 9.14 3.6 b. If the firm's net income is expected to be $1.7 billion, what portion of its net income is the firm expected to pay out as dividends? iefer 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. Hide Feedback IncorrectExplanation / Answer
a. WACC:
proportion of debt * cost of debt ( 1- tax rate ) + proportion of equity * cost of equity = WACC
= 0.55 *0.09 * 0.6 + 0.45 * Re = 0.12
or, 0.0297 + 0.45 * Re = 0.12
0.45 * Re = 0.0903
Re = 20.07 %
the gordon growth model,
D1/ Re - g = P0
d1 = expected dividend = $3
or, 3 / 0.2007 - g = 29
or, 3 = 5.8203 - 29g
or, 2.8203 = 29g
or, g = 9.73 % ( rounded off to two decimal places )
b. growth rate = (1- payout ratio) * ROE
ROE = net income/ equity
= $1.7/ 3.6 = 47.22%
equity = 45% * 8 billion = $3.6
9.73 = ( 1 - payout ratio ) * 47.22
0.2060 = 1 - payout ratio
payout ratio = 79%( rounded off to 2 decimal places )
79% of its earnings is to be distributed as dividends
optional answer :
netincome = $1.7 billion
dividend = 0.79 * netincome = $1.3430 or 1.34 billion per share
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