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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

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

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