Click here to read the eBook The Cost of Retained Earnings r

Click here to read the eBook: The Cost of Retained Earnings, rs Click here to read the eBook: Composite, or Weighted Average, Cost of Capital, WACC WACC AND COST OF COMMON EQUITY 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 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 $2, and the current stock price is $30 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. 25.23 % 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? (Hint: Refer to Equation below.) Growth rate Payout ratio)ROE Round your answer to two decimal places at the end of the calculations. Do not round your

Solution

Weight of Debt = 60%
Weight of Equity = 40%
Before-tax Cost of Debt = 9%
WACC = 16%

WACC = Weight of Debt * Before-tax Cost of Debt * (1 - tax) + Weight of Equity * Cost of Equity
16% = 60% * 9% * (1 - 0.40) + 40% * Cost of Equity
16% = 3.24% + 40% * Cost of Equity
12.76% = 40% * Cost of Equity
Cost of Equity = 31.90%

Answer a.

Cost of Equity = Expected Dividend / Current Price + Growth Rate
31.90% = $2 / $30 + Growth Rate
0.3190 = 0.0667 + Growth Rate
Growth Rate = 0.2523
Growth Rate = 25.23%

Answer b.

Value of Equity = 40% * $8,000 million
Value of Equity = $3,200 million

ROE = Net Income / Value of Equity
ROE = $1,100 million / $3,200 million
ROE = 0.34375

Growth Rate = ROE * (1 - Payout Ratio)
0.2523 = 0.34375 * (1 - Payout Ratio)
0.7340 = 1 - Payout Ratio
Payout Ratio = 0.2660
Payout Ratio = 26.60%