Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at rd = 11%, and its common stock currently pays a $3.00 dividend per share (D0 = $3.00). The stock's price is currently $25.75, its dividend is expected to grow at a constant rate of 4% per year, its tax rate is 40%, and its WACC is 15.85%. 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 After TAx = 11 % * ( 1-0.4)

= 6.6%

Cost of Equity =[ Expected Dividend / Current Price ] + growth rate

= [ ($ 3* 1.04) / $ 25.75] +0.04

= 0.161165048

Let Debt be $ x

Equity be $ y

Total = $ ( x+ y)

WACC = Respective Cost * Respective Weights

0.1585 = x/ (x+y) * 0.066 + y/(x+y) * 0.161165048

0.1585 (x+y)= 0.066x + 0.161165048 y

0.1585 x + 0.1585 y = 0.066x +0.161165048 y

Hence, x = [0.161165048 y - 0.1585y] / (0.1585 - 0.066)

= 0.028811335 y

Total = x+y

= 1.028811335 y

Hence Weight of Debt = 0.028811335 y / 1.028811335 y

= 2.80%

Hence the correct answer is 2.80%