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 $2.75 dividend per share (D0 = $2.75). The stock's price is currently $29.75, its dividend is expected to grow at a constant rate of 5% per year, its tax rate is 25%, and its WACC is 12.15%. 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

Ans:- In this question, we need to find the Percentage of debt. For that first, we need to find the cost of equity (ke)

Cost of equity will be given by [D0 * (1 + g)] / P0 + g, where D0 is the recent dividend distributed, P0 is the current stock price, g is the growth rate.

= [ $2.75 * (1 + 0.05)] / $29.75 + 0.05 = 14.71%

Now the After-tax cost of debt will be rd * ( 1 - tax rate ) = 0.08 * (1 - 0.25) = 0.060.

Now let us assume that weights of debt be x, then weights of equity will be (1 - x)

WACC is given 12.15%

WACC is given by weights of equity * cost of equity + weights of debt * cost of debt.

0.1215  = (1 - x) * 0.1471 + x * 0.06

0.1215 = 0.1471 - x 0.1471 + x 0.06

x 0.1471 - x 0.06 = 0.1471 - 0.1215

x 0.0871 = 0.0256 or x = 0.0256 / 0.0871 = 0.2936 = 29.36%.

Therefore the % of debt in company is 29.36%.