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 $25.50, its dividend is expected to grow at a constant rate of 9% per year, its tax rate is 40%, and its WACC is 14.70%. 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

Answer:

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 + 0.09) / $ 25.50 + 0.09

= 22.892% or 0.22892

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

0.1470 = 0.09 (1 - 0.40) x Y + 0.22892 x (1 - Y)

0.1470= 0.054 Y + 0.22892 - 0.22892 Y

- 0.08192= - 0.17492Y

Y = 0.08192/ 0.17492

Y = 46.83% Approximately