Question

Hook Industries' capital structure consists solely of debt and common equity. It can issue debt at rd = 9%, and its common stock currently pays a $2.25 dividend per share (D0 = $2.25). The stock's price is currently $28.50, its dividend is expected to grow at a constant rate of 8% per year, its tax rate is 40%, and its WACC is 15.40%. What percentage of the company's capital structure consists of debt? Round your answer to two decimal places.

Answer 1

After tax cost of debt=9(1-tax rate)

=9(1-0.4)=5.4%

Cost of equity=(D1/Current price)+Growth rate

=(2.25*1.08)/28.5+0.08=0.165263157(Approx)

Let debt be $x

Equity be ?y

Total=$(x+y)

WACC=Respective costs*Respective weights

0.154=(0.054x/(x+y))+(0.165263157y/(x+y))

0.154(x+y)=0.054x+0.165263157y

0.154x+0.154y=0.054x+0.165263157y

Hence x=(0.165263157-0.154)y/(0.154-0.054)

=0.112631578y

Total =x+y

=1.112631578y

Hence % of debt=(0.112631578y/1.112631578y)

=10.12%(Approx).