Question

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 have 10 years to maturity. What is the company’s return on assets?

Do not round at intermediate steps in your calculation. Express your answer in percent. Round to two decimal places. Do not type the % symbol.

Answer 1

Market value of long-term debt(D) = $20,888 million
Market value of common stock(E) = $171,138 million  
Total Value (V) = DEBT + EQUITY = 20888 + 171138 = 192,026

Beta _equity = 1.11
Cost of equity (R_e) = Risk free rate + Beta * (Market risk - Risk free rate ) = 1% + 1.11 * ( 8% - 1%) = 0.0877 or 8.77%
Cost of Debt R_d = 2.99%
return on assets R_a = (Equity/ Total Value)* Cost of equity + (Debt/ Total Value)* Cost of debt =
(171,138/192,026)* 8.77% + (20888/192,026) * 2.99% = 0.08141 or 8.14

Best of Luck. God Bless