Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at r_d = 10%, and its common stock currently pays a $3.00 dividend per share (D₀ = $3.00). The stock's price is currently $21.25, its dividend is expected to grow at a constant rate of 9% per year, its tax rate is 25%, and its WACC is 14.10%. 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

Answer:

Before tax cost of debt= 10%
After tax cost of debt = 10% * (1 – 0.25)
After tax cost of debt = 7.50%

Current Dividend (D0) = $3.00
Expected Dividend (D1) = $3.00 * (1 + 0.09) = $3.27

Cost of Equity = Expected Dividend / Current Price + Growth rate
Cost of Equity = $3.27 / $21.25 + 0.09
Cost of Equity = 24.39%

Let the proportion of debt in capital structure be “x”
Proportion of equity in capital structure will be “1 – x”

WACC = (Weight of Debt * After tax cost of debt) + (Weight of Equity * Cost of Equity)
0.1410 = (x * 0.0750) + ((1 – x) * 0.2439)
0.1410 = 0.0750x + 0.2439 – 0.2439x
0.1689x = 0.1029
x = 0.6092 or 60.92%

The Capital structure would consists debt of 60.92%