Question

Kahn Inc. (KI) is a distributor of intellectual property. Suppose that you are a member of the financial analyst team at Edward Jones Investments (EJI) and have ascertained the following about KI as of June 15, 2018:

KI’s management desires to maintain a target capital structure of 60% common equity and 40% debt to fund its $10 billion in operating assets.

KI’s WACC is 13%;

KI has a before-tax cost of debt of 10%, and a corporate tax rate of 25%;

KI’s forecast net income is expected to be $1.1 billion;

KI’s retained earnings (aka, internally generated funds) are sufficient to cover all of the equity portion of its capital budget; that is, Ki will not need to issue new common stock for any upcoming capital expenditures (CAPEX);

KI’s expected dividend next year is $3 per common share;

KI’s current stock price is $35.

TASKS: Please -

-Define a corporation’s “sustainable growth rate” and its significance to that corporation’s “capital structure” and “capital budget”;

-Calculate KI’s expected growth rate;

-Determine the portion of KI’s income that it will be expected to pay out as dividends to shareholders if it adheres to its target debt : equity ratio.

-Based on the financial information you have developed for this case scenario, forecast KI’s assets, liabilities, and shareholders’ equity for its next fiscal year ended June 15, 2019. Be sure to state assumptions and logic !

Answer 1

sustainable growth rate = return on equity (roe) * retention ratio (I.e 1- div payout)

higher the retention ratio higher the sustainable growth rate subject to roe

due to higher retention ratio company can use it's internal accrual for capex and need not to rely on outside borrowing this will reduce finance cost and improve margins.

we are given with wacc from can get Ke I.e cost of equity

assume ke = x

therefore 0.6 equity. x 0.6x

0.4 debt. 7.5. 3

1. 13

where cost of debt =7.5% ( 10-25%)

therefore x =16.67

now Ke = d1/p0 +growth rate

16.67 = 3/35*100+ growth rate

growth rate =8.10%

calculations of roe 1.1/10*100= 11%

therefore growth rate = roe * retention ratio

8.10% = 11% * retention ratio

retention ratio = 73.64. %

payout = 26.36% [100 - 73.64]

div amt = 1.1 * 23.36 = 0.28996 billion

asset and liability. amt in billion

equity 6.81004. operating asset 10

debt 4 cash 0.81004

(1.1 - 0.28996) = 0.81004