Problem 1 (20 potats) In March 2019 you and one of your Business Finance classmates were signed the task of estimating Walmart Inc.'s cost of capital (see Exhibits 1 to 5 in the spreadsheet). Walmart mode 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.c. 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 o 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). 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 Page 3 of 3 equity. You learn that Walmart has 2945 million shares outstanding and that its stock was recently trading for $102,20. 1 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. ANSWER: Problem 1 (20 potats) In March 2019 you and one of your Business Finance classmates were signed the task of estimating Walmart Inc.'s cost of capital (see Exhibits 1 to 5 in the spreadsheet). Walmart mode 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.c. 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 o 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). 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 Page 3 of 3 equity. You learn that Walmart has 2945 million shares outstanding and that its stock was recently trading for $102,20. 1 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