Question

Hook Industries’s capital structure consists solely of debt and common equity. It can issue debt at rd5 11%, and its common stock currently pays a $2.00 dividend per share (D05 $2.00). The stock’s price is currently $24.75, its dividend is expected to grow at a constant rate of 7% per year, its tax rate is 25%, and its WACC is 13.95%. What percentage of the company’s capital structure consists of debt?

Answer 1

After-tax Cost of debt

After-tax Cost of debt = Kd x (1 – Tax rate)

= 11.00% x (1 – 0.25)

= 8.25%

Cost of Equity (Ke)

Cost of Equity = [D1 / P0] + g

= [($2.00 x 1.07) / $24.75] + 0.07

= [$2.14 / $24.75] + 0.07

= 0.0865 + 0.07

= 0.1565 or

= 15.65%

WACC

WACC = [Kd x Wd] + [Ke x (1 – Wd)]

0.1395 = [0.0825 x Wd] + [0.1565 x (1 – Wd)]

0.1395 = 0.0825Wd + [0.1565 – 0.1565Wd]

0.1565 – 0.1395 = 0.1565Wd – 0.0825Wd

0.0170 = 0.0740Wd

Wd = 0.0170 / 0.0740

Wd = 0.229730 or

Wd = 22.97%

Therefore, the percentage of the company’s capital structure consists of debt = 22.97%