Question

Kahn Inc. has a target capital structure of 50% common equity and 50% debt to fund its $12 billion in operating assets. Furthermore, Kahn Inc. has a WACC of 14%, a before-tax cost of debt of 12%, and a tax rate of 25%. 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 $33.

1. What is the company's expected growth rate? Do not round intermediate calculations. Round your answer to two decimal places.

     %

2. If the firm's net income is expected to be $1.8 billion, what portion of its net income is the firm expected to pay out as dividends? Do not round intermediate calculations. Round your answer to two decimal places. (Hint: Refer to Equation below.)

   Growth rate = (1 - Payout ratio)ROE

     %

Answer 1

Solution:
a.	Growth rate (g) = 9.91 %
Working Notes:
	For computation of company's growth rate first of all we will get cost of Equity using Weighted Average cost of capital (WACC) formula as details given can be easily used in WACC formula to get Cost of Equity. Then we will the cost of equity to get growth from Gordon growth model formula.
First of WACC	Using Weighted Average Cost of Capital (WACC)
	WACC = We x Ke + Wd x Kd (1-tax rate)
	Where
	We= Weight of Equity in the capital structure =50%
	Wd = Weight of Debt in the capital structure=50%
	Ke= Cost of Equity = ??
	Kd = Cost of Debt = 12%
	Tax rate = 25%
	WACC = 14%
	WACC = We x Ke + Wd x Kd (1-tax rate)
	14% = 50% x Ke + 50% x 12% x (1-25%)
	14% = 50% x Ke + 4.50%
	Ke = (14% - 4.50%)/50%
	Ke =Cost of Equity = 19.00%
Now	We use Gordon Growth model to get Growth rate of the Company
	P0 = D1 / (Ke - g)
	g= Ke - (D1/P0)
	Where
	Po=current share price = $33
	g= growth rate=??
	D1= expected dividend next year (D1) = $3
	Ke= Cost of equity = 19.00% computed above
	g= Ke - (D1/P0)
	g= 19% - ($3/$33)
	g= 19% - 0.090909090909
	g= 19% - 9.090909090909%
	g= Growth rate =9.9090909091%
	g= Growth rate =9.91%
b.	Dividend payout ratio   66.97%
Working Notes:
	Portion of its net income is the firm expected to pay out as dividends is basically known as Dividend payout ratio, which we can compute using growth formula given Growth rate = (1 - Payout ratio)ROE . And for that first of we have to compute return of equity which we get using formula ROE = Net income/ Total Equity , where total equity will equals to weight Equity in total capital structure which is given 50% of total capital.
	Growth rate = (1 - Payout ratio)ROE
	Payout ratio = 1- (Growth rate/ROE)
	Where
	Payout ratio = Dividend payout ratio=?? Which is asked in the question
	Growth rate = g = 9.9090909091% computed in a.
	ROE = Return on Equity =??
	Return on Equity = Net Income/ Total Equity
	Return on Equity = Net Income/ (Total capital x Weight of Equity)
	Return on Equity = 1,800,000,000/(12,000,000,000 x 50%)
	Return on Equity = 0.300
	Return on Equity = 30.00%
At last Payout ratio
	Growth rate = (1 - Payout ratio)ROE
	Payout ratio = 1- (Growth rate/ROE)
	Payout ratio = 1- (9.9090909091%/30.00%)
	Payout ratio = 0.66969697
	Payout ratio = 66.97%
Please feel free to ask if anything about above solution in comment section of the question.