Problem 10-11 WACC and Percentage of Debt Financing Hook Industries\' capital st

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 $2.75 dividend per share (D0 = $2.75). The stock's price is currently $24.00, its dividend is expected to grow at a constant rate of 8% per year, its tax rate is 40%, and its WACC is 12.75%. What percentage of the company's capital structure consists of debt? Round your answer to two decimal places.

_________%

Explanation / Answer

price = dividend next year /(required rate of return - growth rate)

24 = 2.75*(1+8%)/r-8%

=>

cost of equity r = 20.375%

let w be weight of debt

weighted average cost of capital

= weight of debt * cost of debt + weight of equity * cost of equity

= w * 11% * (1-0.4) + (1-w) * 20.375% = 12.75%

=>

0.066w + 20.375% - 0.20375 w = 12.75%

=>

weight of debt w = 0.5535 = 55.35%

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