Check My Work 10-5: The Cost of Retained Earnings, rs 10-7: Composite, or Weight

Question

Check My Work 10-5: The Cost of Retained Earnings, rs 10-7: Composite, or Weighted Average, Cost of Capital, WACC WACC and Cost of Common Equity Kahn Inc. has a target capital structure of 55% common equity and 45% debt to fund its $10 billion in operating assets. Furthermore, Kahn rn 14%, a before tax cost of debt of 12%, and a tax rate of 40%. The company's retained budget. Its expected dividend next year (Di) is $3 and the current stock price is s25. a. What is the compa c. has a WACC of earnings are adequate to provide the common equity portion of its capital ny's expected growth rate? Round your answer to two decimal places at the end of the calculations. b. If the firm's net income is expected to be $1.0 billion, what portion of its net income is the firm expected to pay out as dividends? (Hint: Refer to below.) Growth rate (1 Payout ratio)ROE Round your answer to two decimal places at the end of the calculations

Explanation / Answer

a) Assume ,expected growth rate=g Cost of Equity=Ce After Tax Cost ofDebt=Cd=12*(1-0.4) After tax cost ofDebt=Cd= 7.20% Weightof Debt 0.45 Weightof Equity 0.55 WACC=14% WACC=0.45*7.2+0.55*Ce=14 0.55*Ce=14-(0.45*7.2)=10.76 Cost of Equity=Ce=10.76/0.55= 19.56 Percent Cost of Equity=0.1956 StockPrice= $25 StockPrice=D1/(Ce-g) 25=3/(0.1956-g) 0.1956-g=3/25=0.12 g=0.1956-0.12= 0.0756 Growth rate=g=0.0756=7.56% Expected Growth rate 7.56% b) A Net Income $1,000,000,000 B CommonEquity=0.55*10billion= $        5,500,000,000 C=A/B Return on Equity 0.181818182 Growth rate 0.0756 0.0756=(1-Payout ratio)*0.181818182 1-Payout ratio=0.0756/0.181818182= 0.4158 Payout Ratio=1-0.4158 0.5842 Payout Ratio 0.5842 Portion of Income paid as dividend 0.5842

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