Question

Problem 10-11 WACC and Percentage of Debt Financing Hook Industries' 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 (Do = $3.00). The stock's price is currently $23.25, its dividend is expected to grow at a constant rate of 4% per year, its tax rate is 35%, and its WACC is 15.65%. What percentage of the company's capital structure consists of debt? Round your answer to two decimal places. %

Answer 1

After tax cost of debt = rd * ( 1-tax rate)

= 11% * (1 - 35%)

= 7.15%

Cost of Equity = [Expected Dividend / Current Price] + Growth Rate

= [ $ 3 * (1.04) / $ 23.25 ] + 4%

= 17.41935484%

Let the weight of equity be x

Hence weight of debt = ( 1-x)

WACC = (Cost of Debt * Weight of Debt) + (Cost of Equity * Weight of Equity)

15.65 % = [ 7.15% * ( 1-x) ]+ (17.41935484% * x)

15.65 % = [ 7.15% - 7.15% x + 17.41935484% * x]

15.65 % - 7.15% = (- 7.15% x + 17.41935484% * x)

8.5 % = 10.26935484 % *x

x =8.5 % / 10.26935484 %

x= 82.7705356%

Debt = ( 1-x)

= 1- 82.7705356%

= 17.23%

Hence the correct answer is 17.23%