Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at r_d = 9%, and its common stock currently pays a $3.25 dividend per share (D₀ = $3.25). The stock's price is currently $31.25, its dividend is expected to grow at a constant rate of 4% per year, its tax rate is 35%, and its WACC is 12.60%. 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

The % of the company's debt in the capital structure is computed as shown below:

Let the % of debt be Y. Then the % of equity will be 1 - Y

WACC = cost of debt (1 - tax rate ) x weight of debt + cost of equity x weight of equity

cost of equity is computed as follows:

= Current dividend (1 + growth rate) / current stock price + growth rate

= $ 3.25 (1 + 0.04) / $ 31.25 + 0.04

= 14.816% or 0.14816

So, the weight of debt will be computed as follows:

0.1260 = 0.09 (1 - 0.35) x Y + 0.14816 x (1 - Y)

0.1260 = 0.0585 Y + 0.14816 - 0.14816 Y

- 0.02216 = - 0.08966 Y

Y = 0.02216 / 0.08966

Y = 24.72% Approximately

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