Case Analysis :~t
Read the DATA CASE on page 477 on “Analyze relatively modest changes to Home Depot’s capital
structure.” Prepare your composition to cover the following topics or questions with in the Body
section of the paper described for this assignment:
1. What is Home Depot’s current capital structure? Provide in-text citations for your
sources.
2. How does Home Depot’s capital structure compare to that of other home
improvements stores, such as Lowes?
3. Obtain the financial information you need for Home Depot.
a. Go to www.nasdaq.com.c1ick “Summary Quotes” on the left-hand side, and enter
Home Depot’s stock symbol (HD). Click”Go.” From the Summary Quotes page, get
the current stock price and number of shares outstanding.
b. Click “Company Financials” and the annual income statement should appear. Put the
cursor in the middle of the statement right-click your mouse, and select “Export to
Microsoft Excel.” (You will not need the income statement until Chapter 15, but
collect all of the background data in one step.) Go back to the NASDAQ Web page
and select the balance sheet. Export that to Excel as well and then cut and paste the
balance sheet to the same worksheetas the income statement.
c. To get the cost of debt for Home Depot, go to NASD Bondlnfo
(http://cxa.rnarketwatch.com/finra/BondCenter/Default.aspx ). Select the corporate
toggle, search by symbol and enter Home Depot’s symbol. The next page will
contain information for all of Home Depot’s outstanding and recently matured
bonds. Select the latest yield on an outstanding bond with the shortest remaining
maturity (the maturity date is on the line describing each issue; sometimes the list
also contains recently retired bonds, so make sure not to use one of those). 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’
4. 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.
S. Compute the cost of levered equity (rE) for Home Depot using their current market debtto-equity ratio and Eq. 1 4.5.
6. Compute the current weighted average cost of capital (WACC) for Home Depot
using Eq. 1 4.6 given their current debt-to-equity ratio.
Write a 3 to 5 page paper (1000 to 1500 words) in APA. Below is a recommended outline.
1. Cover page (See APA Sample paper)
2. Introduction
a. A thesis statement
b. Purpose of paper
c. Overview of paper
3. Body
4. Conclusion – Summary of main points
a. lessons learned and Recommendations
5. References -list the references you cited in the text of your paper according to APA format.
(Note: Do not include references that are not cited in the text of your paper)
Book: Corporate Finance: The Core, Second Edition.
DATA CASE
Data Case 477
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. 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 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 using Eq. 14.5 and Eq. 14.6, and assuming a cost of unlevered equity (ru) of 12 percent.
1. Obtain the financial information you need for Home Depot.
a. Go to ,~·,·t”.·.;:.os<lLi.,=·);r” click “Summary Quotes” on the left-hand side, and enter Home
Depot’s stock symbol (HD). Click “Go.” From the Summary Quotes page, get the current
stock price and number of shares outstanding.
b. Click “Company Financials” and the annual income statement should appear. Put the cursor
in the middle of the statement, right-click your mouse, and select “Export to Microsoft
Excel.” (You will not need the income statement until Chapter 15, but collect all of the background data in one step.) Go back to the NASDAQ Web page and select the balance sheet.
Export that to Excel as well and then cut and paste the balance sheet to the same worksheet
as the income statement.
c. To get the cost of debt for Home Depot, go to NASD Bondlnfo C·”c~’. ;c:;’,i<ckc”,’.[;:~,
.::”,:!,i’: iT” ;;(‘:·’.l(~·>,,;,”‘iL\:;’:i(:;· Select the corporate wggle, search by symbol and
enter Home Depot’s symbol. The next page will contain information for all of Home Depot’s
outstanding and recently matured bonds. Select the latest yield on an outstanding bond with
the shortest remaining maturity (the maturity date is on the line describing each issue; sometimes the list also contains recently retired bonds, so make sure not to use one of those). 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 l
D
.
2. Compute the market DIE 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.
3. Compute the cost of levered equity (r
E
) for Home Depot using their current market debt-toequity ratio and Eq. 14.5.
4. Compute the current weighted average cost of capital (WACC) for Home Depot 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. (AIthough you realize that
the cost of debt capital “o may change with changes in leverage, for these modesdy small changes
you decide (0 assume that I’D remains constant. We will explore the relation between changing
leverage and changing Y
D
more fully in Chapter 24.) What is the market DIE 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
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