Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 16%, a before-tax cost of debt of 9%, 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 $4, and the current stock price is $25. What is the company's expected growth rate? If the firm's net income is expected to be $1.4 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

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Business

Russell Sloan

6 December, 04:48

Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 16%, a before-tax cost of debt of 9%, 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 $4, and the current stock price is $25. What is the company's expected growth rate? If the firm's net income is expected to be $1.4 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

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Amir Osborne · Answer 1

Payout ratio = 1 - 12.96%*45%*9/1.4 = 0.6252 or 62.52%

Explanation:

WACC = Weight of Equity * Cost of Equity + Weight of Debt * (1-Tax rate) * Cost of Debt

16% = 45% * Cost of Equity + 55% * (1-40%) * 9%

16%-55% * (1-40%) * 9% = 45%*Cost of Equity

Cost of Equity = 28.9556%

Current price of Stock = D1 / (Cost of Equity - Growth)

25 = 4 / (28.9556%-Growth)

Growth = 28.9556%-4/25 = 12.96%

ROE = Net income/Equity = 1.4 / (45%*9)

Growth rate = (1 - Payout ratio) * ROE

12.96% = (1-Payout ratio) * 1.4 / (45%*9)

Payout ratio = 1 - 12.96%*45%*9/1.4 = 0.6252 or 62.52%