Kahn Inc has a target capital structure of 55 common equity

Kahn Inc. has a target capital structure of 55% common equity and 45% debt to fund its $9 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 12%, 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 $2, and the current stock price is $25.

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.
%

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. Do not round your intermediate calculations.
%

Solution

1)WACC =[after tax cost of debt *weight of debt ] + [cost of equity *Weight of equity]

12 = [10 (1-.40)*.45]+ [CE *.55]

   12 = 2.7+.55 CE

   12 - 2.7 = .55CE

CE = 10.7/.55 = 19.45%

Now dividend discount model ,

P0 =D1/(Rs-g)

25 = 2 / (.1945-g)

.1945-g = 2/25

.1945-g = .08

   .1945 -.08 =g

    g = .1145 or 11.45%

Growth = 11.45%

2)Equity = 9billion*.55 = 4.95 billion

Return on equity = net income /equity

            = 1.2 / 4.95

              = .2424 or 24.24%

Growth rate = ((1-Payout ratio )ROE

11.45 = (1-PR) 24.24

11.45 / 24.24 = (1-PR)

.4724= (1-PR)

   PR = 1- .4724 = .5276 Or 52.76%