Question
I am having trouble seeing this cost of levered equity. I believe I messed up my numbers. Please click the actual open link on the
I am having trouble seeing this cost of levered equity. I believe I messed up my numbers. Please click the actual open link on the excel sheet or it won't open for you. Thank You. There is nothing missing in this 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 equityRu of 12%.
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 and Re=Ru+D/E(Ru-Rd)
Compute the current weighted average cost of capital (WACC) for Home Depot given their current debt-to-equity ratio.
E/E+D Re + D/E+D Rd
Repeat Steps for the two scenarios, 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 capitalRdmay change with changes in leverage, for these modestly small changes you decide to assume thatRd remains constant. What is the market D/E ratio in each of these scenarios?
A written explanation is needed for your boss explaining the relationship between capital structure and the cost of capital in this exercise.
What implicit assumptions in this exercise generate the results found.
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