Back to Assignment Attempts: Keep the Highest: 3 8. Problem 10.15 Problem 10-15

Question

Back to Assignment Attempts: Keep the Highest: 3 8. Problem 10.15 Problem 10-15 WACC and Cost of Common Equity Kahn Inc. has a target capital structure o 45% common equity and 55% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 16% a before-tax cost o debt of 9%, and a tax rate of 40%. The company's retained earnings are adequate to provide the common equity portion of lts capital budget. Its expected dividend next year (D) ls and the current stock price is 0. 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 $1.0 billion, what portion of its net income is the firm expected to pay out as dividends? (Hint: Refer to Equation below.) Growth rate- Payout ratio)ROE Round your answer to two decimal places at the end of the calculations.

Explanation / Answer

a. the first thing that we need to calculate is Cost of Equity (Ke)

Now we know WACC =

WACC = wD*rD *(1-t) + wE*Ke

where:

Thus we get, 0.16 = 0.55 * 9% (1-0.4) + 0.45 *Ke

0.16 = 0.0297 + 0.45 *Ke

Thus Ke = 28.96%

Now the Formula for Price of the Share = D1 /  (Ke - g)

30 = 3 / (0.2896 - g) , That is 0.2896 - g = 3/30

Thus we get g = 18.96%

b) First lets calculate ROE = Net Profit / Equity Capital

Now Equity Capital = 8,000,000 * 45% = 3,600,000

Now net profit = 1,000,000

Thus ROE = 1,000,000 / 3,600,000 = 27.77%

Now We have , g = [1- Payout Ratio] * ROE

That is, 0.1896 = [1- Payout Ratio] * 0.2777

Thus Payout Ratio = 1 - 0.6827 = 31.72%

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.