Hook Industries\' capital structure consists solely of debt and common equity. I
ID: 2719197 • Letter: H
Question
Hook Industries' capital structure consists solely of debt and common equity. It can issue debt at rd = 8%, and its common stock currently pays a $4.00 dividend per share (D0 = $4.00). The stock's price is currently $26.25, its dividend is expected to grow at a constant rate of 6% per year, its tax rate is 40%, and its WACC is 14.50%. What percentage of the company's capital structure consists of debt? Round your answer to two decimal places.
Here is the answer but can someone explanit the formula the solution is using it confuse me a lot!
Explanation / Answer
After tax cost of debt = cost of debt (1 -tax)
= 8 (1-.40)
= 8 *.60
= 4.80%
cost of equity = D0(1+growth ) /current price +growth
= 4(1+.06) /26.25 + .06
= 4 * 1.06 /26.25 + .06
= 4.24/26.25 +.06
= .1615+.06
= .2215 or 22.15%
WACC = (after tax cost of debt *Weight of debt) +(Cost of equity *Weight of equity)
let weight of debt be "X"
Weight of equity = 1 -X [because total weight is always equal to 1]
14.50 = (4.8 *X)+ [22.15 (1-X)]
= 4.8X + [22.15 - 22.15X]
14.50 = 4.80X + 22.15 - 22.15X
14.50 = 22.15 - 17.35 X
17.35X = 22.15 -14.50
17.35X = 7.65
X = 7.65 / 17.35
= .4409
So company should invest /debt consist of .4409 or 44.09% of capital structure.
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