Question

Hook Industries' capital structure consists solely of debt and common equity. It can issue debt at rd = 11%, and its common stock currently pays a $1.75 dividend per share (D0 = $1.75). The stock's price is currently $31.00, its dividend is expected to grow at a constant rate of 9% per year, its tax rate is 35%, and its WACC is 13.45%. 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=11(1-tax rate)

=11(1-0.35)=7.15%

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

=(1.75*1.09)/31+0.09

=0.151532258(Approx)

Let debt be $x

Equity be $y

Total=$(x+y)

WACC=Respective costs*Respective weights

0.1345=(x/(x+y)*0.0715)+(y/(x+y)*0.151532258)

0.1345(x+y)=0.0715x+0.151532258y

0.1345x+0.1345y=0.0715x+0.151532258y

Hence x=(0.151532258-0.1345)y/(0.1345-0.0715)

=0.270353302y

Total=x+y

=1.270353302y

Hence weight of debt=0.270353302y/1.270353302y

=21.28%(Approx).