In March 2019 you and one of your Business Finance classmates were assigned the task of estimating Walmart Inc.'s cost of capital (see Exhibits 1 to 5 in the spreadsheet). Walmart needs this information in order for it to assess the merits of a long-term project. After reviewing all the background material that you were provided, the following issues and ideas come up in your discussion: . The balance sheet provides information on the two capital sources that Walmart uses to finance its assets. You figure that you need to find the cost of each and then average out that number. You start by pondering about the best way to figure out the cost of debt. o Your partner (frustratingly) notes that there are many interest rates available. You raise an important point. Walmart appears to have issued $1 billion of long-term bonds 19 years ago with a coupon rate of 7.55%. These bonds mature in 11 years (2030). You also note that these bonds are currently selling for $1,363.8. You are certain that you can somehow use this information to find the cost of debt for Walmart. o "What about the cost of short-term debt?" your friend asks. Well, according to the unbiased expectations theory, the long-term rates are the market's best guess of what average short-term rates will be. With that in mind, you decide that you don't need to make a distinction between the two rates (i.e. consider them to be the same) You then turn to possible ways you can estimate the cost of equity. o You both recall your professor talking about CAPM and you think that he may have said something about it being a good model to help you figure out the cost of capital. You do a quick Google search for one of its inputs, the stock's beta, and learn that Walmart's beta is 0.71. You go looking for the other inputs, which you put together in a table (see Exhibit 5). Sifting through the materials, you come across a statement from Walmart noting that they anticipate their effective tax rate to be 27%. You are excited about your group's momentum. Then your partner asks, "we need to estimate the weights for the various sources of capital, right?... there are so many items listed under the Liabilities and Equity section of the Balance Sheet, shall we consider all of them?" After thinking long and hard, you conclude that the relevant liabilities are the interest-bearing ones (i.e. Long-term debt & Capital Leases, Current Portion of Long-Term Debt, and Short-term borrowing). o On the Equity side, you decide that you can ignore all but Retained Earnings and Common Stock and Paid-In Capital. It is getting late. One last issue you need to think about and decide on is whether it's more reasonable to use book or market values when estimating the weight of debt and equity. You learn that Walmart ifas 2945 million shares outstanding and that its stock was recently trading for $102.20. 4. What is the cost of capital and why is it important to estimate? ANSWER: b. How should you go about estimating the cost of long-term debt? Explain your answer and the relevant calculations. ANSWER: c. How should you go about estimating the cost of equity? Explain your answer and the relevant calculations ANSWER: d. What is the overall weighted cost of capital? Explain your answer and the relevant calculations. Page 2013 BO3 words Focus st A many MacBook Air DDD no OOO FA FS F1 F2 F3 3.0 2.5 2.0 Yield (%) 1.5 10 0.5 25 0 Os 0.0 --- 3 ooooooooooooo 0 0.25 Time to Matuirty (Years) 2/19/2019 --- 2/20/2011 D Walmart Inc. Consolidated Balance Sheet As of January 31 (SMillions) 2019 2018 ASSETS Current Assets: Cash and Equivalents Accounts Receivable Inventory Prepaid Expenses Total Current Assets 7,722 6,283 44,269 3,623 61,897 6,756 5,614 43,783 3,511 59,664 1 111,395 31,181 14,822 219.295 114,818 18,242 11,798 204.522 2 Net Property, Plant, and Equipment 3 Goodwill 4 Other Long-Term Assets 15 Total Assets 16 17 LIABILITIES 18 Current Liabilities: 19 Accounts Payable 20 Accrued Liabilities 21 Short-Term Borrowings 22 Current Portion of Long-Term Debt & Capital Leases 23 Other Current Liabilities 24 Total Current Liabilities 25 26 Long-Term Debt and Capital Leases 27 Deferred Income Taxes and Other 28 Total Liabilities 29 30 EQUITY 31 Common Stock and Paid-In Capital 32 Retained Earnings 33 Other Comprehensive Income (Loss) 34 Total Common Equity 35 Non-Controlling Interest 36 Total Equity 37 38 Total Liabilities and Equity 39 47,060 22,159 5,225 2,605 428 77,477 46,092 22,122 5,257 4,405 645 78,521 50,203 11,981 139,661 36,825 8,354 123,700 3,253 80,785 (11.542) 72.496 7.138 79.634 2.943 85,107 (10.181) 77,869 2.953 80,822 219.295 204522 22 2018 2019 1 Walmart Inc. Consolidated Income Statement 2 For Year Ending January 31 ($Millions) 3 514,405 500,343 385, 301 373,396 107,147 106,510 492,448 479,906 21,957 20,437 4 5. Revenue 6 Costs and Expenses: 7 Cost of Goods Sold 8 Operating, Selling, General, and Administrative Expenses 9 Total Costs and Expenses 10 Operating Income 11 12 Interest Expense, Net 13 Other Items 14 Income Before Income Taxes 15 16 Income Tax Expense 17 Net Income 18 Net Income Attributable to Non-Controlling Interests 19 Net Income Attributable to Walmart Shareholders 20 (2,129) (8,368) 11,460 (2,178) (3,136) 15,123 4,281 7,179 (509) 6.670 4,600 10,523 (661) 9.862 D 1 Selected Data on Walmart Inc. Common Stock, 2007-2019 E 2 Stock 3 Year EPS DPS Price Total Return 5 2007 2.71 0.67 36.30 10.07% 6 2008 3.12 0.88 37.98 7.04% 7 2009 3.39 0.95 38.36 3.52% 8 2010 3.71 1.09 43.04 15.03% 9 2011 4.47 1.21 42.33 1.15% 10 2012 4.52 1.46 49.43 20.22% 11 2013 5.02 1.59 60.68 25.97% 12 2014 4.88 1.88 65.61 11.23% 13 2015 5.06 1.92 75.56 18.10% 14 2016 4.58 1.96 61.39 -16.17% 15 2017 4.39 2.00 67.54 13.28% 16 2018 3.27 2.04 87.92 33,20% 17 2019 2.28 2.08 96.08 11.64% 18 19 As at fiscal year end, January 31 20 Shares outstanding: 2945 million 21 EPS = earnings per share 22 DPS = dividends per share 23 Total return = (dividend + price change) / previous price 24 B Average Annual Returns in U.S. Capital Markets Over the Period 1928-2018 D E S&P 500 (Includes Dividends) 3-Month Treasury Bill Return on 10- Year Treasury Bond Arithmetic Average 1928-2018 1969-2018 2009-2018 11.36% 11.10% 13.49% 3.43% 4.76% 0.49% 5.10% 7.10% 2.28% 0 Geometric Average 1 1928-2018 12 1969-2018 13 2009-2018 9.49% 9.73% 12.98% 3.38% 4.71% 0.49% 4,83% 6.69% 1.97% 15 16 In March 2019 you and one of your Business Finance classmates were assigned the task of estimating Walmart Inc.'s cost of capital (see Exhibits 1 to 5 in the spreadsheet). Walmart needs this information in order for it to assess the merits of a long-term project. After reviewing all the background material that you were provided, the following issues and ideas come up in your discussion: . The balance sheet provides information on the two capital sources that Walmart uses to finance its assets. You figure that you need to find the cost of each and then average out that number. You start by pondering about the best way to figure out the cost of debt. o Your partner (frustratingly) notes that there are many interest rates available. You raise an important point. Walmart appears to have issued $1 billion of long-term bonds 19 years ago with a coupon rate of 7.55%. These bonds mature in 11 years (2030). You also note that these bonds are currently selling for $1,363.8. You are certain that you can somehow use this information to find the cost of debt for Walmart. o "What about the cost of short-term debt?" your friend asks. Well, according to the unbiased expectations theory, the long-term rates are the market's best guess of what average short-term rates will be. With that in mind, you decide that you don't need to make a distinction between the two rates (i.e. consider them to be the same) You then turn to possible ways you can estimate the cost of equity. o You both recall your professor talking about CAPM and you think that he may have said something about it being a good model to help you figure out the cost of capital. You do a quick Google search for one of its inputs, the stock's beta, and learn that Walmart's beta is 0.71. You go looking for the other inputs, which you put together in a table (see Exhibit 5). Sifting through the materials, you come across a statement from Walmart noting that they anticipate their effective tax rate to be 27%. You are excited about your group's momentum. Then your partner asks, "we need to estimate the weights for the various sources of capital, right?... there are so many items listed under the Liabilities and Equity section of the Balance Sheet, shall we consider all of them?" After thinking long and hard, you conclude that the relevant liabilities are the interest-bearing ones (i.e. Long-term debt & Capital Leases, Current Portion of Long-Term Debt, and Short-term borrowing). o On the Equity side, you decide that you can ignore all but Retained Earnings and Common Stock and Paid-In Capital. It is getting late. One last issue you need to think about and decide on is whether it's more reasonable to use book or market values when estimating the weight of debt and equity. You learn that Walmart ifas 2945 million shares outstanding and that its stock was recently trading for $102.20. 4. What is the cost of capital and why is it important to estimate? ANSWER: b. How should you go about estimating the cost of long-term debt? Explain your answer and the relevant calculations. ANSWER: c. How should you go about estimating the cost of equity? Explain your answer and the relevant calculations ANSWER: d. What is the overall weighted cost of capital? Explain your answer and the relevant calculations. Page 2013 BO3 words Focus st A many MacBook Air DDD no OOO FA FS F1 F2 F3 3.0 2.5 2.0 Yield (%) 1.5 10 0.5 25 0 Os 0.0 --- 3 ooooooooooooo 0 0.25 Time to Matuirty (Years) 2/19/2019 --- 2/20/2011 D Walmart Inc. Consolidated Balance Sheet As of January 31 (SMillions) 2019 2018 ASSETS Current Assets: Cash and Equivalents Accounts Receivable Inventory Prepaid Expenses Total Current Assets 7,722 6,283 44,269 3,623 61,897 6,756 5,614 43,783 3,511 59,664 1 111,395 31,181 14,822 219.295 114,818 18,242 11,798 204.522 2 Net Property, Plant, and Equipment 3 Goodwill 4 Other Long-Term Assets 15 Total Assets 16 17 LIABILITIES 18 Current Liabilities: 19 Accounts Payable 20 Accrued Liabilities 21 Short-Term Borrowings 22 Current Portion of Long-Term Debt & Capital Leases 23 Other Current Liabilities 24 Total Current Liabilities 25 26 Long-Term Debt and Capital Leases 27 Deferred Income Taxes and Other 28 Total Liabilities 29 30 EQUITY 31 Common Stock and Paid-In Capital 32 Retained Earnings 33 Other Comprehensive Income (Loss) 34 Total Common Equity 35 Non-Controlling Interest 36 Total Equity 37 38 Total Liabilities and Equity 39 47,060 22,159 5,225 2,605 428 77,477 46,092 22,122 5,257 4,405 645 78,521 50,203 11,981 139,661 36,825 8,354 123,700 3,253 80,785 (11.542) 72.496 7.138 79.634 2.943 85,107 (10.181) 77,869 2.953 80,822 219.295 204522 22 2018 2019 1 Walmart Inc. Consolidated Income Statement 2 For Year Ending January 31 ($Millions) 3 514,405 500,343 385, 301 373,396 107,147 106,510 492,448 479,906 21,957 20,437 4 5. Revenue 6 Costs and Expenses: 7 Cost of Goods Sold 8 Operating, Selling, General, and Administrative Expenses 9 Total Costs and Expenses 10 Operating Income 11 12 Interest Expense, Net 13 Other Items 14 Income Before Income Taxes 15 16 Income Tax Expense 17 Net Income 18 Net Income Attributable to Non-Controlling Interests 19 Net Income Attributable to Walmart Shareholders 20 (2,129) (8,368) 11,460 (2,178) (3,136) 15,123 4,281 7,179 (509) 6.670 4,600 10,523 (661) 9.862 D 1 Selected Data on Walmart Inc. Common Stock, 2007-2019 E 2 Stock 3 Year EPS DPS Price Total Return 5 2007 2.71 0.67 36.30 10.07% 6 2008 3.12 0.88 37.98 7.04% 7 2009 3.39 0.95 38.36 3.52% 8 2010 3.71 1.09 43.04 15.03% 9 2011 4.47 1.21 42.33 1.15% 10 2012 4.52 1.46 49.43 20.22% 11 2013 5.02 1.59 60.68 25.97% 12 2014 4.88 1.88 65.61 11.23% 13 2015 5.06 1.92 75.56 18.10% 14 2016 4.58 1.96 61.39 -16.17% 15 2017 4.39 2.00 67.54 13.28% 16 2018 3.27 2.04 87.92 33,20% 17 2019 2.28 2.08 96.08 11.64% 18 19 As at fiscal year end, January 31 20 Shares outstanding: 2945 million 21 EPS = earnings per share 22 DPS = dividends per share 23 Total return = (dividend + price change) / previous price 24 B Average Annual Returns in U.S. Capital Markets Over the Period 1928-2018 D E S&P 500 (Includes Dividends) 3-Month Treasury Bill Return on 10- Year Treasury Bond Arithmetic Average 1928-2018 1969-2018 2009-2018 11.36% 11.10% 13.49% 3.43% 4.76% 0.49% 5.10% 7.10% 2.28% 0 Geometric Average 1 1928-2018 12 1969-2018 13 2009-2018 9.49% 9.73% 12.98% 3.38% 4.71% 0.49% 4,83% 6.69% 1.97% 15 16