Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at rd = 12%, and its common stock currently pays a $3.50 dividend per share (D0 = $3.50). The stock's price is currently $30.50, its dividend is expected to grow at a constant rate of 4% per year, its tax rate is 40%, and its WACC is 13.55%. 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

After tax cost of debt = rd x (1-Tax)

After tax cost of debt = 12% x (1-40%)

After tax cost of debt or Cost of Debt = 7.20%

.

Cost of equity = (Dividend x (1+Growth rate)/Current price) + Growth rate

Cost of equity = (3.5 x (1+4%)/30.5) + 4%

Cost of equity = 15.93%

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Weight of debt = W and weight of equity = 1-W

WACC = Cost of equity x Weight of equity + Cost of debt x Weight of debt

13.55% = 15.93% x (1-W) + 7.2% x W

13.55% = 15.93% - 15.93% x W + 7.2% x W

8.73% x W = 15.93% - 13.55%  

W = 2.38%/8.73%

W = 27.26%

And hence, 1-W = 72.74%

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Weight of Debt = 27.26% or 0.27

Weight of equity = 72.74% or 0.73

Note: I have given rounding in percentage form and also in non-percentage form and both are in two decimal places; Please pick wisely which ever is suited to you