Case Study

Walmart Inc.
is an American multinational retail corporation that operates a

chain of hypermarkets, discount department stores, and grocery stores,
headquartered in !Bentonville, Arkansas!. The company was founded by !
Sam Walton
in 1962, the first Walmart store was opened in Rogers, Arkansas. Later,
Walmart
became a publicly traded company. The first stock is sold at $16.50 per share.
In
1980, Walmart reached $1 billion in annual sales, faster than any other
company at
that time. In 2019, Walmart’s !revenue reached $514.4 billion and it employs
over 2.2
million associates worldwide.
SUMMARY
Walmart Inc. is an American multinational retail corporation that
operates a chain of hypermarkets, discount department stores, and
grocery stores, headquartered in Bentonville, Arkansas. The first
Walmart store was opened in Rogers, Arkansas and founded by Sam
Walton in 1962. The senior managers, Dale and Lee from the
technology firms who attended the executive education program that
will provide them background that is related in estimating a firm’s cost
of capital. As what they have gathered, it is necessary to estimate the
costs of capital, cost of debt, and cost of equity. However, there are
such cases which involves several methods in estimating the cost of
capital, for instance the weighted average cost of capital (WACC) that
estimates the cost of capital of a firm in which classification of capital
must be weighted respectively.
What is the cost of capital? Why do Dale and Lee care about cost of
capital?
Capital is the money
that companies use to
finance their operations.
The cost
of capital is a necessary
required rate of return
when it comes to a
capital budgeting
or an investment
decision. It typically
means the weighted
average of a company's
source of funds, e.g.
debt and equity,
blended together.
Generally, a company
raises funds from many
different sources and
does
business with those
funds. A company has
an obligation to give a
return to its
funding providers. If a
company has only one
source of financing,
then its cost is the
minimum amount at
which it is required to
earn from the business.
However, many
companies use more
than one source of
funds to finance their
business and, for
such companies, the
overall cost of capital is
derived from the
weighted average cost
of all capital, which is
widely known as the
weighted average cost
of capital (WACC).
In conclusion, !Dale
and Lee care about the
cost of capital because
they want
to know what is the
appropriate minimum
rate that Walmart
should use as its
benchmark when it
comes to an investment
decision for each
different project. Also,
regarding valuation,
they can use WACC as
a discount rate in the
discounted cash
flow model.
The cost of capital is essential most especially when it comes to capital
budgeting or an investment decision you must know its required rate of
return. The weighted average of a company, determines the sources of
funds like debt and equity, which is combined together. In general, when a
company raises their funds from different sources and sort out business with
those funds, then the company has an obligation to give a return to its
funding providers. On the other hand, if a company has only one source of
financing, then its cost would be the minimum amount to which it is
required to earn from the business. Nevertheless, there are some
companies that uses more than one sources of fund to finance their
business and the overall cost of capital may be derived from its weighted
average cost of all capital, or commonly known as the weighted average cost
of capital (WACC). Therefore, Dale and Lee must care about on their cost of
capital since they wanted to know what would be the appropriate minimum
rate should the Walmart use as its benchmark regarding to investment
decision for each different project. Also, in regards to valuation, the usage of
WACC as their discount rate in the discounted cash flow model.
How should Dale and Lee go about estimating the cost of long-term debt?
(Sample: Discuss the different alternatives or types of debt instrument and
how will they consider the tax)
Cost of debt occurs in a company to finance their capital through the use of
debt instruments such as bank loans or bonds, which also means the required
rate of return on a company’s debt capital. Mostly, long-term debts can be
divided into two types of instruments, like bonds and long-term loans, whereas
each type of the instrument comes from different nature and interest rate.
Therefore, the cost of long-term debt should be the weighted rate between cost
of bonds and cost of long-term loans. In regards with the cost of bonds, it is
estimated by using the average yield-to-maturity (YTM) of company’s bonds. The
YTM is a discount rate sum of the debt cash flows (specifically coupon and
principal payments) must be equal to the market price of the debt. That is why
YTM is used as the cost of debt since it represents the internal rate of return by
means of debt holder that has already been concerned nearly on the company's
credit. Furthermore, there such companies that issues more than one bond.
Therefore, their cost of bonds must be the weighted of each bond yield-to-
maturity (YTM) that can be used as bond’s face value as a weighting factor. As
presumed, that this approach would help the company to issue bonds at the same
rating that the company’s rates the overall credits. However, this approach is only
limited and useful if and only if the bond is publicly traded. In such cases that
bonds will not be publicly traded, then the cost of the bond can be estimated
through the use of the Bond-Rating approach. In contrast, it normally uses the
average of historical long-term loan interest rates as a cost of long-term loans. In
this case, due to lack of information, it is presumed that long-term debt of
Walmart is essentially structured by bonds. In result to the domination of the
bond’s IRR over long-term loan’s IRR, it is assumed that the average of all bonds
of Walmart’s YTM will approximately be the same as the given bond’s YTM, which
is 3.53%.
If Walmart had preferred shares, or planned to issue preferred shares, how
would Dale and Lee deal with them?
Preferred stock is usually considered as a hybrid instrument that can
be seen as a combination between an equity and a debt instrument. It is a
stock which offers different rights to a shareholders than common stock.
Whenever the company is experiencing bankruptcy, the preferred
shareholders must be prioritized and receives regular dividends that are
repaid first than the common stock holders. Therefore, if Walmart planned
to issue preferred shares, Dale and Lee must calculate first their cost by
dividing the annual preferred dividend to the market price per share.
Afterwards, when the preferred share rate has been determined, then they
can used it to compare to their financing options to compute the WACC.
Because apparently, it affects the weighted average cost of capital or the
WACC especially in cost of equity since it calculates the price and the return
of the perpetual instrument. With this, it is assumed that the constant
amount of dividend paid to preferred shareholders and the company will
not be bankrupt. Thus, if Dale and Lee decides to finance their company
with preferred shares, the WACC must be changed in order to replicate all
costs of the company's sources of funds. However, adding preferred stock as
another source of fund will increase the WACC and reduces the tax shield to
be less impact to the company which results to a decreased in debt weight.
How should Dale and Lee deal with deferred taxes?

Deferred tax may result from the depreciable assets. It occurs when
the accounting tax is greater than the actual tax. Consequently, when Dale
and Lee calculates their tax in financial accounting, then it will be greater
than the actual tax, therefore, they will recognize it as the deferred tax
liability on the differential between its accounting earnings before taxes and
taxable income. If it continues to depreciate its assets, the difference
between the straight-line method and the accelerated depreciation narrows
and the amount of deferred tax liability is gently removed through a series
of compensating accounting entries. In regards to the weighted average cost
of capital or the WACC, some may be realized the deferred tax as a source of
funds that the government provides and uses it to calculate the WACC.
However, the deferred tax should not be included in the WACC calculation
since the finances given by the government is interest free. Nonetheless,
the deferred tax might affect the assessment of the company as deferred tax
liabilities can be recognized as firm’s future liabilities. It would lower the
value of the company as it anticipates to pay all of these liabilities in the
future.
How might Dale and Lee go about estimating the cost of equity?
Dale and Lee can use the CAPM model in order to calculate their
company’s cost of equity. It includes the risk-free rate, market return, and
beta. However, in determining the risk-free rate, they can use the 10-years
U.S. Treasury bond’s yield at 2.65% since the raw and the adjusted beta are
both present. Hence, adjusted beta of 0.71 in the CAPM model is
appropriate to use since there is a possibility that the stock return will move
correlated with average market return. And for their market return, they
can use the geometric mean of S&P500 return from 2009 to 2018 which is
equals to 12.98% and it includes the compounding effect of the return from
time to time. So to sum up the information given, Dale and Lee’s cost of
equity is 9.98%.
What is the overall weighted average cost of capital? (Discuss you
computation and the basis of your capital structure)
In this case, debt and

equity are only two
company’s sources of
funds, WACC
can be computed by the
below formula
In this case, debt and
equity are only two
company’s sources of
funds, WACC
can be computed by the
below formula
In this case, debt and equity are the company’s sources of funds, and
the weighted average cost of capital or the WACC can be computed with the
given formula. First, we need to compute the market value of the equity, we
must know the current market price share and common shares outstanding
since it is necessary. In the given statement, the current market price per
share is $102.20 and the common shares outstanding is 2,945 million.
Therefore, we need to multiply the market price per share, $102.20 and the
common share, 2,945,000, it would result to 300,979. Second, compute the
market value of debt to determine both short-term and long-term debt from
2018-2019. In order to get the result for the short-term debt, add the
amounts of 2018 and 2019 and divide it into 2, same goes by on the long
term debt. After getting the result of both short-term and long term, add the
sum and result would be 52,260. Third, compute the weight of equity and
weight debt. The pro forma for the weight of equity would be like this,
market value of equity which is the 300,979 divided by the sum of 300,979
(market value of equity) and 52,260 (market value of debt). Therefore
300,979 divided by 353,239 is equals to 0.85. And for the weight of debt,
simply divide the 52,260 (market value of debt) to 353,239 (sum of market
value of equity and debt) is equals to 0.15. Fourth, compute the cost of debt
using the interest-bearing short-term debt weight of 0.10 and multiply it
with the given three-month commercial paper of 2.73 and the result would
be 0.273. Next, for the interest-bearing long-term weight of 0.90 multiplied
with the given bond’s yield to maturity of 3.53 the result would be 3.177.
Then add the interest-bearing both 0.273 (short-term weight) and 3.177
(long-term weight) the cost of debt would be 3.45%. And lastly, compute for
the WACC using the formula given and use all the information mentioned
earlier, the result is 8.90%.
How does all of this relate to hurdle rate that Walmart might use?
Hurdle rate could be at least an adequate rate of return (MARR) which
is utilized as a cost of capital for all project and investment. Owing to the
fact that hurdle rate is being utilized in making such critical expenditure
choices, the rate ought to constitute the toll of financing, commerce
openings, affiliated risks and other components that might influence the
business project or the investment. WACC is seen as a benchmark required
rate of return by the venture capitalist. Normally, most companies typically
utilize WACC as a hurdle rate when making a speculation choice on a new
venture. Thus, the company should secure that the internal rate of return
(IRR) from the project is exceptional than WACC preliminary to financing
some project. Within the same way, WACC as well as utilized as a discount
rate for deducting future cash flows in Net present value (NPV)
measurement. Under this approach, NPV is presumed to be positive to
receive sanction. In case isn’t, the project is expected to be rejected.
Nevertheless, if WACC act for the cost of capital of the entire company,
when investment verdict on distinct project is made, hurdle rate doesn’t
continuously to be equivalent with WACC. WACC act for risks of the entire
company, to produce efficiency and the shareholder ought to alter the
WACC to make it appropriate for the intended project. Otherwise stated, for
risky projects, hurdle rate be likely higher due to risk premium
compensation. Therefore, if the project is further risky is, the hurdle rate
might be vice versa. To sum up, WACC may be utilized as a proper hurdle
rate for Walmart. Since WACC is viewed as a least rate of return that
company ought to make for its shareholder. Whilst a suitable hurdle rate
ought to be tune by its risk premium for the risky projects.

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What is the cost of capital and why do Dale and Lee care about it?

How is the weighted average cost of capital (WACC) calculated?

Walmart Inc.

is an American multinational retail corporation that operates a

How should Dale and Lee deal with deferred taxes?

In this case, debt and

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