Kahn Inc. has a target capital structure of 40% common equity and 60% debt to fu

Question

Kahn Inc. has a target capital structure of 40% common equity and 60% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, 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 $2 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? (Hint: Refer 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.

Explanation / Answer

Return on Equity = X

=> WACC = Debt ratio * cost of debt * ( 1 - tax rate) + Equity ratio * Return on Equity

= 0.60 * 0.08 (1 - 0.40) + 0.40 * X = 0.14

so, X = 0.278 or 27.80%

A: the company's expected growth rate:

=> D1 / R - g = Current Stock Price, putting the value in the formula

= $2 / 0.278 - g = $29 and solving it for the g, we get

Company's expected growth rate = g = 0.209 or 20.90%

B. The portion of its net income is the firm expected to pay out as dividends = Payout ratio

=> Growth rate = (1 - Payout ) ROE

=> (1 - Payout Ratio) 0.278 = 0.209 and solving it for Payout Ratio, we get

Payout Ratio = 24.82%

Of the Net Income $1.60 billion, the payout as dividends = $1.60 billion * 24.82% = $0.40 billion

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