You work in the corporate finance division of The Home Depot and your boss has asked you to review the firm’s capital structure. Specifically, your boss is considering changing the firm’s debt level. Your boss remembers something from his MBA program about capital structure being irrelevant, but isn’t quite sure what that means. You know that capital structure is irrelevant under the conditions of perfect markets and will demonstrate this point for your boss by showing that the weighted average cost of capital remains constant under various levels of debt. Income Statements Total Revenue $70,395,000 Cost of Revenue $46,133,000 Gross Profit $24,262,000 Operating Expenses Sales, General and Admin. $16,028,000 Other Operating Items $1,573,000 Operating Income $6,661,000 Add'l income/expense items $13,000 Earnings Before Interest and Tax $6,674,000 Interest Expense $606,000 Earnings Before Tax $6,068,000 Income Tax $2,185,000 Net Income-Cont. Operations $3,883,000 Net Income $3,883,000 Net Income Applicable to $3,883,000 Common Shareholders Balance Sheet Current Assets Cash and Cash Equivalents $1,987,000 Short Term Investments $0 Net Receivables $1,245,000 Inventory $10,325,000 Other Current Assets $963,000 Total Current Assets $14,520,000 Long Term Assets Long Term Investments $135,000 Fixed Assets $24,448,000 Goodwill $1,120,000 Intangible Assets $0 Other Assets $295,000 Total Assets $40,518,000 Current Liabilities Accounts Payable $8,199,000 Short Term Debt/Current Portion of Long Term Debt $30,000 Other Current Liabilities $1,147,000 Total Current Liabilities $9,376,000 Long Term Debt $10,758,000 Other Liabilities $2,146,000 Deferred Liability Charges $340,000 Total Liabilities $22,620,000 Stock Holders Equity Common Stocks $87,000 Capital Surplus $6,966,000 Retained Earnings $17,246,000 Treasury Stock ($6,694,000) Other Equity $293,000 Total Equity $17,898,000 So, for now, suppose that capital markets are perfect as you prepare responses for your boss based on the financial statements above. 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. Assume a cost of unlevered equity (RU) of 12%. Currently the share price is USD 61.77 whilst number of shares outstanding is 1,510,000,000. Market value of debt is USD 10,788,000,000 with a yield to maturity of 0.434%.
You work in the
review the firm’s capital structure. Specifically, your boss is considering changing the firm’s debt
level. Your boss remembers something from his MBA program about capital structure being
irrelevant, but isn’t quite sure what that means. You know that capital structure is irrelevant under
the conditions of perfect markets and will demonstrate this point for your boss by showing that
the weighted average cost of capital remains constant under various levels of debt.
Income Statements
Total Revenue $70,395,000
Cost of Revenue $46,133,000
Gross Profit $24,262,000
Operating Expenses
Sales, General and Admin. $16,028,000
Other Operating Items $1,573,000
Operating Income $6,661,000
Add'l income/expense items $13,000
Earnings Before Interest and Tax $6,674,000
Interest Expense $606,000
Earnings Before Tax $6,068,000
Income Tax $2,185,000
Net Income-Cont. Operations $3,883,000
Net Income $3,883,000
Net Income Applicable to $3,883,000
Common Shareholders
Balance Sheet
Current Assets
Cash and Cash Equivalents $1,987,000
Short Term Investments $0
Net Receivables $1,245,000
Inventory $10,325,000
Other Current Assets $963,000
Total Current Assets $14,520,000
Long Term Assets
Long Term Investments $135,000
Fixed Assets $24,448,000
Goodwill $1,120,000
Intangible Assets $0
Other Assets $295,000
Total Assets $40,518,000
Current Liabilities
Accounts Payable $8,199,000
Short Term Debt/Current Portion of Long Term Debt $30,000
Other Current Liabilities $1,147,000
Total Current Liabilities $9,376,000
Long Term Debt $10,758,000
Other Liabilities $2,146,000
Deferred Liability Charges $340,000
Total Liabilities $22,620,000
Stock Holders Equity
Common Stocks $87,000
Capital Surplus $6,966,000
Retained Earnings $17,246,000
Treasury Stock ($6,694,000)
Other Equity $293,000
Total Equity $17,898,000
So, for now, suppose that capital markets are perfect as you prepare responses for your boss based
on the financial statements above. 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.
Assume a
number of shares outstanding is 1,510,000,000. Market value of debt is USD 10,788,000,000 with
a yield to maturity of 0.434%.
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