Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at r_d = 11%, and its common stock currently pays a $3.25 dividend per share (D₀ = $3.25). The stock's price is currently $26.50, its dividend is expected to grow at a constant rate of 7% per year, its tax rate is 25%, and its WACC is 15.65%. What percentage of the company's capital structure consists of debt? Do not round intermediate calculations. Round your answer to two decimal places.

  %

Answer 1

The % is computed as shown below:

Let the % weight of debt be Y. Then the % weight of equity will be (1 - Y)

WACC = cost of debt x (1 - tax rate) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= [ D0 x (1 + growth rate) / current price ] + growth rate

= [ ($ 3.25 x 1.07) / $ 26.50 ] + 0.07

= 0.201226415

So, the % of weight of debt will be as follows:

0.1565 = 0.11 x (1 - 0.25) x Y + 0.201226415 x (1 - Y)

0.1565 = 0.0825 Y + 0.201226415 - 0.201226415 Y

0.1565 =  0.201226415 - 0.118726415 Y

Y = (0.201226415 - 0.1565) / 0.118726415

Y = 37.67% Approximately

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