You work in the corporate finance division of Singapore Airlines Limited 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. So, for now, suppose that capital markets are perfect as you prepare responses for your boss.

You would like to analyze relatively modest changes to Singapore Airlines’ 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 using Eqs.14.5 and14.6  and assuming a cost of unlevered equity (rU) of 12%.1.

Obtain the financial information you need for Singapore Airlines.

a. Go to the website of Singapore’s stock exchange (https://www2.sgx.com), click on the

“Securities” tab, enter Singapore Airlines, and click the search button. Under “Profile”, obtain the current stock price and find the number of shares outstanding.

b. Go to Yahoo! Finance, enter Singapore Airlines and press the search button. Click the

“Financials” tab to see the annual income statement for the last four years. Copy all the data and export it to Excel. Next, click the “Balance Sheet” tab. Export the balance sheet data to Excel and paste it into the same worksheet as the income statement.

c. To get the cost of debt for Singapore Airlines, go to https://secure.fundsupermart.

com/fsm/general-search/. Under general search, enter “SIAPSP”. The information of all Singapore Airlines outstanding bonds will be shown. Select the latest yield on an outstanding bond with the shortest remaining maturity (the maturity date is on the line describing each issue). Use “Asked Yield to Maturity.” 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. 2.

Compute the market D/E ratio for Singapore Airlines. 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. 3.

Compute the cost of levered equity (rE ) for Singapore Airlines using their current market debtto-

equity ratio and Eq.14.

5.4.

Compute the current weighted average cost of capital (WACC) for Singapore Airlines using Eq.14.

6 given their current debt-to-equity ratio.5.

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 more fully in Chapter 24.

) What is the market D/E ratio in each of these cases? 6.

Prepare a written explanation for your boss explaining the relationship between capital structure and the cost of capital in this exercise. 7.

What implicit assumptions in this exercise generate the results found in Question 5? How might your results differ in the “real world”?