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 Lo

$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%.