Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at rd = 8%, and its common stock currently pays a $1.50 dividend per share (D0 = $1.50). The stock's price is currently $33.25, its dividend is expected to grow at a constant rate of 9% per year, its tax rate is 40%, and its WACC is 12.10%. 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

Cost of Debt = 8.00%

Last Dividend = $1.50
Growth Rate = 9.00%
Current Price = $33.25

Expected Dividend = Last Dividend * (1 + Growth Rate)
Expected Dividend = $1.50 * 1.09
Expected Dividend = $1.635

Cost of Equity = Expected Dividend / Current Price + Growth Rate
Cost of Equity = $1.635 / $33.25 + 0.09
Cost of Equity = 0.13917 or 13.917%

Let weight of debt be x% and weight of equity be (1 - x)%

WACC = Weight of Debt * Cost of Debt * (1 - Tax Rate) + Weight of Equity * Cost of Equity
0.1210 = x * 0.08 * (1 - 0.40) + (1 - x) * 0.13917
0.1210 = x * 0.0480 + (1 - x) * 0.13917
0.1210 = x * 0.0480 + 0.13917 - x * 0.13917
x * 0.09117 = 0.01817
x = 0.1993 or 19.93%

Weight of Debt = 19.93%