Walmart Case

II. Estimate the Weighted Average Cost of Capital (WACC) of Walmart:

1. Define the dollar amount of “debt” use only interest bearing loans as
the most recent balance date
At January 31, 2010, Walmart had total short-term debt is $4,919 million
which includes $523 million of outstanding commercial paper and short-term
borrowing obligations, $4,050 million of long-term debt due within one year
and $346 million of the obiligation under capital leases due within one year.

The company also had $36,401 million of long-term debt outstanding

including $33,231 million of long-term borrowings and $3,170 million of
long-term obligation under capital lease.

Base on these information, we calculation the Walmart’s Total Debt which

interest bearing as following:
No Debt Balance (Mil USD)
1 Long-term Debt 36,401
2 Short-term Debt 4,919
Total Debt 41,320

2. Define the dollar amount of equity, base on two separate calculations:

2.1 Market value of equity as at balance date– share price * number of
common stock on issue:
As at balance date, the market value of equity
2.2 Book value of equity as at the last balance date:

3. Estimate the rate of interest on debt:

At January 31, 2010, for short-term debt, weighted-average interest rate,
including fees, on these obligations at January 31, 2010 and 2009 was 1.8%
and 0.9%, respectively. A hypothetical 10% increase in these rates in effect at
January 31, 2010 and 2009 would have increased the annual interest expense
for the respective outstanding balances by $1 million.
For long-term debt, Walmart’s weighted-average effective interest rate,
after considering the effect of interest rate swaps, was 4.5%.

4. Estimate the cost of equity base on 2 models:

4.1 The Dividen Growth Model:

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The constant growth model assumes that dividends will increase by the
same increment every year. The equation used is Po – D1/ (Ke-g). This
equation also assumes that the cost of equity is greater than the dividend
growth rate. For Wal-Mart this is not true. Using the growth rate of 12%,
as projected by Value-Line, the equation cannot be solved because Wal-
Mart’s cost of equity is only 10.8%.
*Constant Growth Model

Po=D1/(Ke-g) Po = .32/(.108-.12)

*This model cannot be used because the cost of capital is less than the growth rate.

The above chart is drawn based on 20 years dividend data. From this chart, we get
the dividend growth rate of 32.84%. However, return on equity for Wal-Mart is only
10.27%. Therefore, since the dividend growth rate exceeds the return on equity we
cannot use this dividend model. This happens because Wal-Mart acquired its fund
externally by splitting its stocks several times in the last 20 years, where CAPM
assumes that a company should generate its fund internally (see Appendix for more
details).
As a result, we formulate the dividend model based on three years period, which
produce much more realistic figure.

4.2 The Capital Asset Pricing Model (CAPM):

In order to use any of these models, the cost of equity must be determined.
The capital asset pricing model is a model that helps find an appropriate
cost of equity for a company. The CAPM uses the risk-free rate, beta, and
market risk premium to derive the cost of equity (Ke = Rf + βRm). The
risk-free rate used to determine the cost of equity was the ten year U.S.
Treasury Bond(3.43%). Any shorter treasury bond will give an inaccurate
estimate because rates are presently low ; the cost of equity will be lower
but this is not sustainable because rates will eventually increase and we
are looking for long-run estimates.

The beta in the equation is the individual company’s risk. The beta for
Wal-Mart was found using “Value-Line”. Their beta which was 0.89,
means Wal-Mart is a less risky investment than the market. This is very
good for risk-adverse investors.

The market risk premium is 8.3% found from Standard and Poors.

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Containing these figures, the cost of equity for Wal-Mart is 10.8% (Ke =
3.43% + .89 x 8.3%).
The formula for CAPM is as follows:
E(Re) = Rf + β (E(Rm) – Rf)
Rf = Risk free rate
β = Systematic risk
E(Rm) = Expected market return
Risk free rate is calculated based on US government 3-month Treasury bill, which
has a rate of 1.65%. We utilised this figure based on our assumption that US
government Treasury bill has zero risk.
Based on this formula we got the average monthly returns then we annualised them
by multiplying the returns by twelve, which is 0.092153.
For beta calculation, we evaluate the relation between Wal-Mart share price return
and market index return. We utilised regression tool available in Excel, which
resulted in 1.139011736 (see Appendix for more details).
Based on CAPM rationale, the coefficient intercept must be of zero value, however
as seen in the regression output the intercept has a value of 0.013970211. Therefore,
we worked out hypothesis (H0: α = 0; H1: α ≠ 0) for α with degree of freedom of 241 (n-
1) and 5% significant level. The t0.05,241 = 1.645 (based on table). However, t Stat
indicated a value of 3.335541339, which is bigger than 1.645. Thus, we reject H0
(therefore there is a relationship between prices with other factors). This means that
there is an economic profit on our CAPM, where this is not allowed on CAPM. In
other words, it is possible for us to use CAPM, but it will not cover all aspects.
Lastly, by using these variables, the return on equity (Re) is 0.102669 (10.27%).

5. Estimate the WACC:

5.1 Dividen Growth Model with the Book Value of equity:

5.2 Dividen Growth Model with the Market Value of equity:

5.3 CAPM with the Book Value of equity:

5.4 CAPM with the Market Value of equity:

6. Conclusion:
We should base on average WACC
Apart from the DDM & FCF valuation, it is clear that Wal-Mart is a very healthy company.
Some of the supporting factors are: constant level of debt-to-equity, steady increase of net
income, and sound liquidity (5-year current ratio ranges between 0.92 and 1.34). However,
since Wal-Mart does not give significant cash dividend compared with its current share
price, so DDM is not applicable in this situation. In addition, FCF method also did not
produce satisfying outcome (there is still a huge difference between our valuation price and
current share price). But we also have checked other analysts’ recommendation and most
of them suggest BUY, although they found out the fair value of the price is $52.10 per share
(it is still higher than current share price of $57.80).

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Therefore, our HOLD recommendation is based on Wal-Mart financial performance for the
past 10 years. We could not suggest this HOLD recommendation based on the dividend
growth as well as discounted cash flow method.

BALANCE SHEET

Period Ending (mill USD) Jan. 31, 2010 Jan. 31, 2009 Jan. 31, 2008
Assets
Current Assets
Cash And Cash Equivalents 7,907 7,275 5,569
Accounts Receivables 4,144 3,905 3,654
Inventory 33,160 34,511 35,180
Other Current Assets 3,120 3,258 3,182
Total Current Assets 48,331 48,949 47,585
Property Plant and Equipment 102,307 95,653 97,017
Goodwill 16,126 15,260 16,071
Other Assets 3,942 3,567 2,841
Deferred Long Term Asset Charges - - -
Total Assets 170,706 163,429 163,514
Liabilities
Current Liabilities
Accounts Payable 50,550 47,638 44,278
Short/Current Long Term Debt 4,919 7,669 11,269
Other Current Liabilities 92 83 2,907
Total Current Liabilities 55,561 55,390 58,454
Long Term Debt 36,401 34,549 33,402
Deferred Long Term Liability
5,508 6,014 5,111
Charges
Minority Interest 2,180 1,794 1,939
Total Liabilities 99,650 97,747 98,906
Stockholders' Equity
Misc Stocks Options Warrants 307 397 -
Common Stock 378 393 397
Retained Earnings 66,638 63,660 57,319
Capital Surplus 3,803 3,920 3,028
Other Stockholder Equity (70) (2,688) 3,864
Total Stockholder Equity 70,749 65,285 64,608

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