Question 8 You have the follow

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January 18th, 2023

Question 8

You have the following data on The Home Depot, Inc.

Market value of long-term debt: $20,888 million

Market value of common stock: $171,138 million

Beta: 1.04

Yield to maturity on debt with 10 years to maturity: 2.167%

Expected return on equity: 8.771%

Marginal tax rate: 35%

Assume that if Home Depot issues new bonds, the bonds will have10 years to maturity.

Suppose that managers at Home Depot decide to increase theproportion of debt to 20% of the value of the company. The managersestimate that yield on the company’s 10 year bonds will rise to2.413% if the company changes its capital structure in thismanner.

What would be the expected rate of return on equity under thenew capital structure?

Do not round at intermediate steps in your calculation. Expressyour answer in percent. Round to two decimal places. Do not typethe % symbol.

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Question 7

You have the following data on The Home Depot, Inc.

Market value of long-term debt: $20,888 million

Market value of common stock: $171,138 million

Beta: 1.11

Yield to maturity on debt with 10 years to maturity: 2.99%

You also have the following market data:

Expected annual return on the market portfolio: 8%

Annual risk-free rate: 1%

Assume that if Home Depot issues new bonds, the bonds will have10 years to maturity. What is the company’s return on assets?

Do not round at intermediate steps in your calculation. Expressyour answer in percent. Round to two decimal places. Do not typethe % symbol.

Answer:

Q8.Market value of long-term debt: $20,888 millionMarket value of common stock: $171,138 millionTotal value = 20,888 + 171,138 = 192,026Under Capm new Cost of equity = risk free rate + beta * (Marketreturn – Risk free rate )Market return =( 8.771% – 2.617%)/1.04 + 2.167% = 0.080843 or8.0843%Beta levered = 1.04Beta Unlevered = Beta Levered /(1 + (1 -tax rate )*D/E) =1.04/(1+(1-35%)*20888/171,138) = 0.96355643715After new Capital StructureDebt / Equity = 20%/80% = 1/4Beta Levered New = Beta unlevered* ( 1+ (1 -tax rate)*D/E) =0.96355643715* (1+(1-35%)*1/4) = 1.1201343New Cost of Equity = New Risk free Rate + Betanew * ( Market return- new risk free rate) =2.413% + 1.1201343 *( 8.0843% – 2.413%) = 0.0877 or8.77

Q7.Market value of long-term debt(D) = $20,888 millionMarket value of common stock(E) = $171,138 million

Total Value (V) = DEBT + EQUITY = 20888 + 171138 = 192,026

Beta _equity = 1.11Cost of equity (R_e) = Risk free rate + Beta * (Marketrisk – Risk free rate ) = 1% + 1.11 * ( 8% – 1%) = 0.0877 or8.77%Cost of Debt R_d = 2.99%return on assets R_a = (Equity/ Total Value)* Cost ofequity + (Debt/ Total Value)* Cost of debt =(171,138/192,026)* 8.77% + (20888/192,026) * 2.99% = 0.08141 or8.14Best of Luck. God Bless

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