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Hook Industries's capital structure consists solely of debt and common equity. It can issue debt at...

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.

Solutions

Expert Solution

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%

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