5. WACC AND PERCENTAGE OF DEBT FINANCING Hook Industries\'s capital structure co

Question

5. WACC AND PERCENTAGE OF DEBT FINANCING 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 $2.00 dividend per share (D0 = $2.00). The stock's price is currently $28.00, its dividend is expected to grow at a constant rate of 6% per year, its tax rate is 40%, and its WACC is 12.35%. What percentage of the company's capital structure consists of debt? Do not round intermediate calculations. Round your answer to two decimal places.

Explanation / Answer

Cost of debt after tax=9(1-0.4)=0.054

Cost of equity=(Dividend for next period/Current price)+Growth rate

=(2*1.06)/28+0.06=0.135714285

Let debt be $x

Equity be $y

Total=$(x+y)

WACC=Respective costs*Respective weights

0.1235=(0.054x/(x+y))+(0.135714285y/(x+y)

0.1235(x+y)=0.054x+0.135714285y

0.1235x+0.1235y=0.054x+0.135714285y

x=y(0.135714285-0.1235)/(0.1235-0.054)

=0.175745118y

Hence total =x+y

=1.175745118y

Hence weight of debt=0.175745118y/1.175745118y

=14.95%(Approx)

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