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 -

A. Calculate KI’s expected growth rate;

B. 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.

C. 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

Operating Asset cost = $ 10 billion

Target Capital structure - 60% equity & 40% Debt

WACC - 13%, cost of debt - 10%, corporate tax- 25%

Forecast Income - $ 1.1 Billion

expected divident - $3 per share

CMP - $35

1. calculation of expected growth rate-

let return on equity be x

WACC=Equity/Operating capital * + Debt/Operating capital* debt rate(1-Tax)

13=6/10*x + 4/10*10(1-.25)

x=16.67%

now,

35 = divident/ke - g =3/.1667- g

g = 8.08%

2. income that will be expected to pay out as divident to equity shareholder

Income - 1.1 Billion

less - Paid to debt - ( .3 Billion) (assumed that total no of debt instrument issued are 400000000 of $10 each)

=for equity s/h's- .8 Billion (this portion expected to payout as divident to shareholder)

3. In Asset side - fixed asset company have operating Asset of $ 10 Billion and Othere Asset of $ 6 Billion (Assumed)

In Liability side company have debt of $ 4 Billion

In Equity shareholder fund we have equity share capital  $ 6 Billion (we have assumed we have equity share capital of $ 6 Billion that is equal to retained earning) & reserve Fund - $ 6 Billion (specific)

in this balance sheet item we have assumed that we have equal amount of bank balance as in retained earning. therefore, we are able to pay amount to buy asset journal entry would be these :

1. Fixed Assets A/c Dr To, Party/Bank A/c
2. Reserve Fund (Specific) A/c Dr To Retained Earning