Question

Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at rd = 9%, and its common stock currently pays a $2.75 dividend per share (D0 = $2.75). The stock's price is currently $29.50, 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

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

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

Now the % of debt is computed as follows:

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

cost of equity is computed as follows:

= Dividend currently paid (1 + growth rate) / current stock price + growth rate

= $ 2.75 x (1 + 0.05) / $ 29.50 + 0.05

= 0.147881356

So, the % of debt will be:

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

0.1215 = 0.09 (1 - 0.25) x Y + 0.147881356 x (1 - Y)

0.1215 = 0.0675 Y + 0.147881356 - 0.147881356 Y

0.147881356 Y - 0.0675 Y = 0.147881356 - 0.1215

0.080381356 Y = 0.026381356

Y = 0.026381356 / 0.080381356

Y = 32.82% Approximately

Hence, the % of debt in the company's capital structure is 32.82%

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