Question

Miller Von Enterprises' capital structure consists solely of debt and common equity. It can issue debt at rd = 11.6%, and its common stock currently pays a $1.95 dividend (D0= $1.95). The stock's price is currently $24.70, its dividend is expected to grow at a constant rate of 7.4% per year, its tax rate is 45%, and its WACC is 13.88%. What percentage of the company's capital structure consists of debt? Round your answer to two decimal places. Show your work to receive full credit.

Answer 1

Cost of debt after tax=11.6(1-tax rate)

=11.6(1-0.45)=6.38%

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

=(1.95*1.074)/24.70+0.074

=15.8789473%

Let debt be $x

Equity be $y

Total=$(x+y)

WACC=Respective costs*Respective weights

13.88=(6.38x/(x+y))+(15.8789473y/(x+y))

13.88(x+y)=6.38x+15.8789473y

13.88x+13.88y=6.38x+15.8789473y

Hence x=(15.8789473-13.88)y/(13.88-6.38)

=0.266526315y

Total=x+y

=1.266526315y

Hence weight of debt=0.266526315y/1.266526315y

which is equal to

=21.04%(Approx).