11.14 DIVIDENDS-BASED VALUATION OF COMMON EQUITY. Problem 10.16 projected financial statements for Walmart for Years +1 through +5. The following data for Walmart include the actual amounts for 2008 and the projected amounts for Year +1 to Year +5 for comprehensive income and common shareholders' equity (assuming Walmart will use implied dividends as the financial flexible account to balance the balance sheet; amounts in millions). EARN Actual 2008 Year +1 Year +2 Year +3 Year +4 Comprehensive Income $ 6,848 $13,995 $15,024 $16,126 Common Shareholders' Equity: Paid-In Capital Retained Earnings $ 4,313 63,50 $ 4,744 5,219 68,692 77,018 $ 5,741 80,957 Year +5 $17,306 $18,569 $ 6,315 $ 6,946 93,955 97,024 Accumulated Other Comprehensive Income (2,688) Total Common Equity (2,688) $70,749 (2,688) (2,688) (2,688) (2,688) $79,549 $ 84,010 $97,582 $101,282 The market equity beta for Walmart at the end of 2008 was 0.80. Assume that the risk- free interest rate was 3.5 percent and the market risk premium was 5.0 percent. Walmart had 3,925 million shares outstanding at the end of 2008, and share price was $46.06. Required a. Use the CAPM to compute the required rate of return on common equity capital for ROPERTY OF CE b. Compute the weighted average cost of capital for Walmart as of the start of Year +1. At the end of 2008, Walmart had $42,218 million in outstanding interest-bearing debt on the balance sheet and no preferred stock. Assume that the balance sheet value of Walmart's debt is approximately equal to the market value of the debt. Assume that at the start of Year +1, Walmart will incur interest expense of 5.0 per- cent on debt capital and that Walmart's average tax rate is 34.2 percent. Use the clean surplus accounting approach to derive the projected dividends for Walmart for Years +1 through +5 based on the projected comprehensive income and shareholders' equity amounts. d. Use the clean surplus accounting approach to project the continuing dividend in Year +6. Assume that the steady-state long-run growth rate will be 3 percent in Year +6 and beyond. e. Using the required rate of return on common equity from Part a as a discount rate, compute the sum of the present value of dividends for Walmart for Years +1 through +5. f. Using the required rate of return on common equity from Part a as a discount rate and the long-run growth rate from Part d, compute the continuing value of Walmart as of the beginning of Year +6 based on Walmart's continuing dividends in Years +6 NIN and beyond. After computing continuing value, bring continuing value back to pres- ent value at the start of Year +1. g. Compute the value of a share of Walmart common stock. (i) Compute the sum of the present value of dividends including the present value of continuing value. (ii) Adjust the sum of the present value using the midyear discounting adjust- ment factor. (iii) Compute the per-share value estimate. h. Using the same set of forecast assumptions as before, recompute the value of Walmart shares under two alternative scenarios. Scenario 1: Assume that Walmart's long-run growth will be 2 percent, not 3 percent as before, and assume that Walmart's required rate of return on equity is 1 percentage point higher than the rate you computed using the CAPM in Part a. Scenario 2: Assume that Walmart's long- run growth will be 4 percent, not 3 percent as before, and assume that Walmart's required rate of return on equity is I percentage point lower than the rate you com- puted using the CAPM in Part a. To quantify the sensitivity of your share value esti- mate for Walmart to these variations in growth and discount rates, compare (in percentage terms) your value estimates under these two scenarios with your value estimate from Part g. i. What reasonable range of share values would you expect for Walmart common stock? Where is the current price for Walmart shares relative to this range? What do you recommend