WACC and Cost of Common Equity Kahn Inc. has a target capital structure of 65% c
ID: 2715409 • Letter: W
Question
WACC and Cost of Common Equity Kahn Inc. has a target capital structure of 65% common equity and 35% debt to fund its $10 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 $4 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.
b) If the firm's net income is expected to be $1.2 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.
Explanation / Answer
Answer:a)
WACC=We*Ke+Wd*Kd
16%=0.65*Ke+0.35*[8%(1-0.40)]
16%=0.65 Ke+1.68%
Ke=22.03%
Po=D1/Ke-g
$29=$4/0.2203-g
6.3887-29g=4
g=8.24%
Answer:b ROE=$1.2 billion/6.5 billion=18.46%
Growth rate = (1 - Payout ratio)ROE
8.24%=(1-x)18.46%
x=5.54%
Net income portion=1.2 billion*5.54%=0.06648 billion
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