K-Structure for Home Depot

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We found the optimal capital structure for Home Depot (NYSE: HD).

Historical K-Structure & WACC

The WACC is used as an indicator to determine whether or not an investment is worthwhile and is generally the rate at which a company yields returns for its investors. Home Depot is generating funds through the issuing of both stock and debt. Since Home Depot has a stable cash flow generation, we expect the cash flows from operating activities to be strong in future years

Optimal K-Structure & WACC

Assumptions for Home Depot’s K-Structure Optimization: we used a general market risk premium of 6.5%. Using the 10-year treasury rate, we concluded the risk free rate to be 1.96%. We rounded the regression between three monthly stock prices and the S&P 500 stock prices to find the beta. The optimal capital structure of Home Depot is a WACC of 6.49% at a weight of 50% equity and a weight of 50% debt.

Change in Value

If we assume the no growth model, we get a change in value of $10,118 million. The stock price change is $7.97, which is 6.14% of $129.68 current price. We also consider using a growth rate model. The value change under the 5% growth model is $4260.93 million. The stock price change is $27.1, which is 20.89% of the $129.68 current price.

Recommendations

According to trade-off theory, we suggest Home Depot should issue more debt and issue less equity due to the tax benefit. Home Depot has strong financial ability and credibility to take on more debt. Ergo, our recommendation to lever up will indeed reduce the WACC dramatically and greatly benefit both our investors and Home Depot itself.

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