Key Transaction Effect on Honeywell Inc.'s Cost of Capital

What effect will reducing the debt-equity ratio have on Honeywell Inc.'s cost of capital?

Will this transaction impact HON's equity cost of capital and weighted average cost of capital (WACC)?

Impact of Transaction on Cost of Capital

The transaction will have no effect on HON's equity cost of capital or weighted average cost of capital (WACC) in perfect capital markets.

Honeywell Inc. (HON) is planning to issue equity and use the proceeds to repay its debt, reducing its debt-equity ratio from 0.5 to 0.4. This adjustment will lower the cost of debt capital from 6.5% to 5.75%. However, according to the Modigliani-Miller theorem in perfect capital markets, this change in capital structure will not impact the cost of equity or the weighted average cost of capital.

The Modigliani-Miller theorem states that the overall cost of capital and the cost of equity for a firm remain constant regardless of changes in its capital structure, assuming perfect capital markets. This means that any reduction in the cost of debt capital due to a lower debt-equity ratio will be offset by adjustments in the cost of equity, maintaining the equilibrium of the weighted average cost of capital.

Therefore, despite the positive effect of reducing the debt-equity ratio on the cost of debt, Honeywell Inc.'s equity cost of capital and weighted average cost of capital will not be impacted by this transaction. The Modigliani-Miller theorem highlights the resilience of firm value and cost of capital in idealized market conditions.

In conclusion, Honeywell Inc.'s decision to lower its debt-equity ratio through issuing equity and repaying debt will not influence its equity cost of capital or weighted average cost of capital in perfect capital markets, as per the Modigliani-Miller theorem.