WACC AND COST OF COMMON EQUITY Kahn Inc has a target capital

WACC AND COST OF COMMON EQUITY Kahn Inc. has a target capital structure of 45% common equity and 55% debt to fund its $8 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 12%, a before-tax cost of debt of 996, 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 $3, 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. 9.14 3.6 b. If the firm\'s net income is expected to be $1.7 billion, what portion of its net income is the firm expected to pay out as dividends? iefer 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. Hide Feedback Incorrect

Solution

a. WACC:

proportion of debt * cost of debt ( 1- tax rate ) + proportion of equity * cost of equity = WACC

= 0.55 *0.09 * 0.6 + 0.45 * Re = 0.12

or, 0.0297 + 0.45 * Re = 0.12

0.45 * Re = 0.0903

Re = 20.07 %

the gordon growth model,

D1/ Re - g = P0

d1 = expected dividend = $3

or, 3 / 0.2007 - g = 29

or, 3 = 5.8203 - 29g

or, 2.8203 = 29g

or, g = 9.73 % ( rounded off to two decimal places )

b. growth rate = (1- payout ratio) * ROE

ROE = net income/ equity

= $1.7/ 3.6 = 47.22%

equity = 45% * 8 billion = $3.6

9.73 = ( 1 - payout ratio ) * 47.22

0.2060 = 1 - payout ratio

payout ratio = 79%( rounded off to 2 decimal places )

79% of its earnings is to be distributed as dividends

optional answer :

netincome = $1.7 billion

dividend = 0.79 * netincome = $1.3430 or 1.34 billion per share