MBA 702 Walmart Case Questions

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North Dakota State University *

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702

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Finance

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Apr 3, 2024

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Walmart Case Questions by Jayden Roos 1. What is the cost of capital? Why do Dale and Lee care about the cost of capital? The cost of capital is the rate of return that is required by investors or lenders to invest in a company’s equity or debt. It is the cost a company incurs to finance its operations and grow its business. It represents the minimum return that a company must generate to create value for its shareholders. The cost of capital includes the cost of debt and the cost of equity. If the cost of capital is too high, it could potentially lead to a decrease in profitability and a decline in the company’s stock price. Dale and Lee care about the cost of capital because they need to determine the minimum return that Walmart must generate to create value for its shareholders. It helps in determining the feasibility of a project. If the cost of capital is too high, Walmart may reject potentially profitable investments, which can lead to missed growth opportunities. Therefore, it is recommended that Dale and Lee should estimate the cost of capital accurately to help Walmart take their next steps as a company. 2. How should Dale and Lee go about estimating the cost of long-term debt? Long-term debt cost is generally estimated based on the interest paid on long-term debt instruments such as bank loans or bonds. The cost of long-term debt should be a weighted average of the cost of bonds and the cost of long-term loans. In the case of bonds, the cost of debt can be estimated using the average yield-to-maturity of the company’s bonds. Yield- to-maturity represents the internal rate of return by the debtholder, who is already concerned about the company’s creditworthiness. If a company issues more than one bond, the cost of bonds should be the weighted average of each bond’s YTM, with bond face value as the weighting factor. Walmart has multiple bonds so it might not be feasible to calculate the cost of debt as the weighted average of each bond's YTM using face value as a weighting factor. Therefore, it is reasonable to assume that the total bond YTM for Walmart will be approximately equal to the YTM of the given bond. With Walmart, Dale and Lee should assume that its long-term debt is mainly structured by bonds, resulting in the domination of the bond’s internal rate of return over the long-term loan’s internal rate of return. Furthermore, Dale and Lee should assume that the average yield-to-maturity of all Walmart’s bonds will be approximately the same as the given bond’s yield to maturity, which is 3.53%. 3. How might Dale and Lee estimate the cost equity? The best way that Dale and Lee could estimate the cost of equity is to use the dividend discount model (DDM) or the capital asset pricing model (CAPM). The dividend discount model is only used for companies that give out a consistent dividend, which Walmart does, but it is not as popular an option compared to the capital asset pricing model. I feel like

Dale and Lee should use the capital asset pricing model to determine the cost of equity at Walmart. Re = Rf + B * (Rm – Rf) Re = cost of equity Rf = risk-free rate B = beta Rm – Rf = difference between the expected return on the market portfolio and the risk-free rate Re = 2.65% + 0.71 * (12.98% - 2.65%) Re = 2.65% + 0.71(10.33%) Re = 2.65% + 7.33% Re = 9.98% 4. What is the overall weighted average cost of capital (WACC)? WACC = ((Equity weight * cost of equity) + (Debt weight * cost of debt) * (1 – tax rate)) Equity weight = 0.85 Debt weight = 0.15 WACC = ((0.85 * 9.98%) + (0.15 * 3.53%) * (1-.27)) WACC = 8.45% + (0.53% * .73) WACC = 8.45% + 0.39% WACC = 8.84% This is assuming that Walmart’s effective tax rate is at 27%. Walmart’s equity market price amounts to $300,979 million (current market share price * number of common shares outstanding) and the total interest-bearing debt (short term-borrowings + Total Long-term debt and capital leases) between 2018 and 2019 is $52,260 million. 5. How does all of this relate to hurdle rates that Walmart might use? The hurdle rate is the minimum rate of return that a project or investment must achieve to be deemed acceptable. When evaluating new investment opportunities, most companies use the WACC as a benchmark for determining the minimum acceptable rate of return or hurdle rate. This means that the internal rate of return of a project must exceed the

WACC to be considered a viable investment. Riskier projects generally require a higher hurdle rate to compensate for the increased risk, while less risky projects have a lower hurdle rate. The appropriate hurdle rate for Walmart would be: WACC + Project risk premium

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