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 $34.00, its dividend is expected to grow at a constant rate of 9% per year, its tax rate is 40%, and its WACC is 15.55%. 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

Step-1:Calculation of cost of equity
	As per dividend discount model,
	Cost of equity	=	(D0*(1+g)/P0)+g			Where,
		=	(3.00*(1+0.09)/34.00)+0.09			D0	$       3.00
		=	18.62%			g	9%
						P0	$    34.00
Step-2:Calculation of after tax cost of debt
	After tax cost of debt	=	Before tax cost of debt*(1-Tax rate)
		=	11%*(1-0.40)
		=	6.60%
Step-3:Calculation of weight of debt and equity
	Suppose weight of debt is "w" and so weight of equity is "1-w".
	WACC	=	Sum of weighted tax of each component
	0.1555	=	(w*0.066)+((1-w)*0.1862)
	0.1555	=	0.066w+0.1862-0.1862w
	0.1555	=	-0.1202w+0.1862
	0.1202w	=	0.1862-0.1555
	0.1202w	=	0.0307
	w	=	0.255408
	so,
	1-w	=	0.744592
Thus,
Capital structure consists of debt with				25.54%