Kahn Inl. has a target capital structure of 60% common equity and 40% debt to fu
ID: 2664797 • Letter: K
Question
Kahn Inl. has a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operationg assets. Futuremore, Kahn Inc. has a WACC of 13%, a before-tax cost of debt of 10%, 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 $35.a) What is the company's expected growing rate ?
b) If the firm's net income is expected to be $ 1.1 billion, what portion of its net income is the firm expected to pay out as dividends ?
Explanation / Answer
Target Capital Structure:
Common Equity 60% (or) 0.60
Debt 40% (or) 0.40
Operating Assets = $10 billion
WACC = 13%
Before-tax Cost of Debt = 10%
Tax Rate = 40%
After-tax Cost of Debt = 10% (1-0.40)
After-tax Cost of Debt =
Expected Dividend (D1) = $3
Current Stock price (P0) = $35
(a) What is the Company’s expected growing rate?
WACC = [(E/V) * RE + (D/V) * RD]
13% = [(0.60 * RE) + (0.40 * 0.06)]
0.13 = [(0.60 * RE) + 0.024]
0.13 – 0.024 = (0.60 * RE)
0.106 = (0.60 * RE)
(0.60 * RE) = 0.106
RE = [0.106 / 0.60]
RE = 0.1766 (or) 17.66%
Cost of Common Equity (or) Cost of Equity = 17.66%
17.66% = [($3 / $35)] + g
0.1766 = 0.085714 + g
0.1766 – 0.085714 = g
0.090886 = g
Growth rate (g) = 9.08%
Company’s Expected growing rate = 9.08%
Firm’s Net Income = $1.1 billion
Expected dividend to pay = $3 per share
Dividend payout ratio = [Cash dividends / Net Income]
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