Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at...

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at rd = 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.

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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%

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