With the help of the Excel spread sheet provided, compute the market debt to equity (D/E) ratio for HDC. Then use it to compute the current cost of equity (rE) and the pretax-WACC for HDC.

QUESTIONS: Capital structure: market debt to equity (D/E) ratio for HDC

  1. With the help of the Excel spread sheet provided, compute the market debt to equity (D/E) ratio
    for HDC. Then use it to compute the current cost of equity (rE) and the pretax-WACC for HDC.
    Assuming the cost of unlevered equity (rU) is 12%. (Hint: the market value of debt equals its book
    value; it is the sum of Long-Term Debt and Short-Term Debt.)
    At present Kyle is considering the following share repurchase proposal from the firm’s CFO: the
    company could raise $5 billion new debt (on permanent basis) at a competitive rate of 0.58% to
    repurchase shares.
  2. Compute the market D/E ratio, rE and pretax-WACC in this scenario.
  3. Compare your results in Questions 1 and 2. Explain the relationship between capital structure
    and the cost of capital with no taxes (as if in perfect markets). How would the weight average
    cost of capital (WACC) differ if the effect of taxes is incorporated? Justify.
    Assume that Kyle was impressed by your discussion in Question 3. He now understands that interest
    is tax deductable and the firm could potentially benefit from issuing more debt. Kyle decides to issue
    $5 billion of debt (on permanent basis) and use the proceeds to repurchase shares.
  4. What is the present value of interest tax shield (ITS) of the new debt?
  5. At the announcement of the repurchase, what is the new market value of the equity and the
    share price (assume no arbitraging)?
  6. After the repurchase, how many shares are outstanding? How has this deal affected the total
    value of the firm?
    Payout policy
  7. If HDC adopts a 100% dividend payout policy, what is the after-tax dividend income of a
    shareholder whose personal tax rate is 36%, in 1) a classic tax system; and 2) the imputation tax
    system? Which tax system would he/she favour? Why?
    Other
  8. Are there any downside to this deal? Justify

IMPORTANT INSTRUCTIONS


• Complete your assignment in MS Word using size 11 pt Times New Roman font and 1.5 line
spacing.
• The attached MS Excel spread sheet tables must be completed and pasted into your
assignment as appendixes.
• CLEARLY SHOW THE BASIS OF YOUR CALCULATIONS in the main text, so that partial credit can
be earned where possible.
• On the front page of your submission, include your tutorial time, tutor’s name, group member
names and their student numbers.
• SUBMIT THE PDF DOCUMENT ONLY. Excel files are not acceptable.
• PAGE LIMIT: 5 PAGES (excluding tables).
Q Assessment Criteria Mark
Allocation
1 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 6
2 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 8
3 Succinct discussion (no calculation needed) 5
4 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 4
5 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 5
6 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 5
7 Complete the spread sheet table, and show your workings and answer
clearly in the Word document. 8
8 Succinct discussion (no calculation needed) 4
Total 45
SPARK – PEER ASSESS

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