You would like to analyze relatively modest changes to Home Depot's capital structure. You would like to
Question:
You would like to analyze relatively modest changes to Home Depot's capital structure. You would like to consider two scenarios: the firm issues $1 billion in new debt to repurchase stock, and the firm issues $1 billion in new stock to repurchase debt. Use Excel to answer the following questions and assuming a cost of unlevered equity (rU) of 12%.
For simplicity, since you are just trying to illustrate the main concepts for your boss, you may use the existing yield on the outstanding bond as rD.
Compute the market D/E ratio for Home Depot. Approximate the market value of debt by the book value of net debt; include both Long-Term Debt and Short-Term Debt/Current Portion of Long-Term Debt from the balance sheet and subtract any cash holdings. Use the stock price and number of shares outstanding to calculate the market value of equity.
Compute the cost of levered equity (rE) for Home Depot using their current market debt-to-equity ratio
Compute the current weighted average cost of capital (WACC) for Home Depot given their current debt-to-equity ratio.
Repeat Steps 3 and 4 for the two scenarios you would like to analyze, issuing $1 billion in debt to repurchase stock, and issuing $1 billion in stock to repurchase debt. (Although you realize that the cost of debt capital rD may change with changes in leverage, for these modestly small changes you decide to assume that rD remains constant. We will explore the relation between changing leverage and changing rD.
What is the market D/E ratio in each of these cases?
What implicit assumptions in this exercise generate the results found in Question 5?
How might your results differ in the "real world"?
| HD Financials Income Statement | ||||
| Period Ending: | 1/31/2021 | 2/2/2020 | 2/3/2019 | 1/28/2018 |
| Total Revenue | $132,110,000 | $110,225,000 | $108,203,000 | $100,904,000 |
| Cost of Revenue | $87,257,000 | $72,653,000 | $71,043,000 | $66,548,000 |
| Gross Profit | $44,853,000 | $37,572,000 | $37,160,000 | $34,356,000 |
| Operating Expenses | ||||
| Research and Development | -- | -- | -- | -- |
| Sales, General and Admin. | $24,447,000 | $19,740,000 | $19,513,000 | $17,864,000 |
| Non-Recurring Items | -- | -- | $247,000 | -- |
| Other Operating Items | $2,128,000 | $1,989,000 | $1,870,000 | $1,811,000 |
| Operating Income | $18,278,000 | $15,843,000 | $15,530,000 | $14,681,000 |
| Add'l income/expense items | $47,000 | $73,000 | $77,000 | $74,000 |
| Earnings Before Interest and Tax | $18,325,000 | $15,916,000 | $15,607,000 | $14,755,000 |
| Interest Expense | $1,347,000 | $1,201,000 | $1,051,000 | $1,057,000 |
| Earnings Before Tax | $16,978,000 | $14,715,000 | $14,556,000 | $13,698,000 |
| Income Tax | $4,112,000 | $3,473,000 | $3,435,000 | $5,068,000 |
| Minority Interest | -- | -- | -- | -- |
| Equity Earnings/Loss Unconsolidated Subsidiary | -- | -- | -- | -- |
| Net Income-Cont. Operations | $12,866,000 | $11,242,000 | $11,121,000 | $8,630,000 |
| Net Income | $12,866,000 | $11,242,000 | $11,121,000 | $8,630,000 |
| Net Income Applicable to Common Shareholders | $12,866,000 | $11,242,000 | $11,121,000 | $8,630,000 |
| HD Financials Balance Sheet | ||||
| Period Ending: | 1/31/2021 | 2/2/2020 | 2/3/2019 | 1/28/2018 |
| Current Assets | ||||
| Cash and Cash Equivalents | $7,895,000 | $2,133,000 | $1,778,000 | $3,595,000 |
| Short-Term Investments | -- | -- | -- | -- |
| Net Receivables | $2,992,000 | $2,106,000 | $1,936,000 | $1,952,000 |
| Inventory | $16,627,000 | $14,531,000 | $13,925,000 | $12,748,000 |
| Other Current Assets | $963,000 | $1,040,000 | $890,000 | $638,000 |
| Total Current Assets | $28,477,000 | $19,810,000 | $18,529,000 | $18,933,000 |
| Long-Term Assets | ||||
| Long-Term Investments | -- | -- | -- | -- |
| Fixed Assets | $30,667,000 | $28,365,000 | $22,375,000 | $22,075,000 |
| Goodwill | $7,126,000 | $2,254,000 | $2,252,000 | $2,275,000 |
| Intangible Assets | -- | -- | -- | -- |
| Other Assets | $4,311,000 | $807,000 | $847,000 | $1,246,000 |
| Deferred Asset Charges | -- | -- | -- | -- |
| Total Assets | $70,581,000 | $51,236,000 | $44,003,000 | $44,529,000 |
| Current Liabilities | ||||
| Accounts Payable | $18,099,000 | $12,618,000 | $12,539,000 | $11,628,000 |
| Short-Term Debt / Current Portion of Long-Term Debt | $1,416,000 | $2,813,000 | $2,395,000 | $2,761,000 |
| Other Current Liabilities | $3,651,000 | $2,944,000 | $1,782,000 | $1,805,000 |
| Total Current Liabilities | $23,166,000 | $18,375,000 | $16,716,000 | $16,194,000 |
| Long-Term Debt | $35,822,000 | $28,670,000 | $26,807,000 | $24,267,000 |
| Other Liabilities | $7,163,000 | $6,601,000 | $1,867,000 | $2,174,000 |
| Deferred Liability Charges | $1,131,000 | $706,000 | $491,000 | $440,000 |
| Misc. Stocks | -- | -- | -- | -- |
| Minority Interest | -- | -- | -- | -- |
| Total Liabilities | $67,282,000 | $54,352,000 | $45,881,000 | $43,075,000 |
| Stock Holders Equity | ||||
| Common Stocks | $89,000 | $89,000 | $89,000 | $89,000 |
| Capital Surplus | $58,134,000 | $51,729,000 | $46,423,000 | $39,935,000 |
| Retained Earnings | ($65,793,000) | ($65,196,000) | ($58,196,000) | ($48,196,000) |
| Treasury Stock | $11,540,000 | $11,001,000 | $10,578,000 | $10,192,000 |
| Other Equity | ($671,000) | ($739,000) | ($772,000) | ($566,000) |
| Total Equity | $3,299,000 | ($3,116,000) | ($1,878,000) | $1,454,000 |
| Total Liabilities & Equity | $70,581,000 | $51,236,000 | $44,003,000 | $44,529,000 |
| BONDS | |||||||||
| Issuer Name | Symbol | Callable | Sub-Product Type | Coupon | Maturity | Moody's | S&P | Price | Yield |
| HOME DEPOT INC | HD.GK | Yes | Corporate Bond | 5.875 | 12/16/2036 | A2 | A | 141.027 | 2.591 |
Expert Answer:
Fundamentals Of Corporate Finance
ISBN: 9781265553609
13th Edition
Authors: Stephen Ross, Randolph Westerfield, Bradford Jordan
