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How should Dale and Lee estimate the cost of long-term debt? Should short-term debt be considered in calculating cost of capital?

How should Dale and Lee estimate the cost of long-term debt? Should short-term debt be considered in calculating cost of capital?

Practical Management Science
Practical Management Science
6th Edition
ISBN:9781337406659
Author:WINSTON, Wayne L.
Publisher:WINSTON, Wayne L.
Chapter2: Introduction To Spreadsheet Modeling
Section: Chapter Questions
Problem 20P: Julie James is opening a lemonade stand. She believes the fixed cost per week of running the stand...
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  1. How should Dale and Lee estimate the cost of long-term debt? Should short-term debt be considered in calculating cost of capital?

 

EXHIBIT 2: WALMART INC., CONSOLIDATED BALANCE SHEET AS OF JANUARY 31 ($ MILLIONS) 2019 2018 ASSETS Current Assets: Cash and Equivalents 7,722 6,756 Accounts Receivable 6,283 5,614 Inventory Prepaid Expenses Total Current Assets 44,269 43,783 3,623 3,511 61,897 59,664 Net Property, Plant & Equipment 111,395 114,818 Goodwill 31,181 18,242 Other Long-Term Assets 14,822 219.295 11,798 Total Assets 204.522 LIABILITIES Current Liabilities: Accounts Payable 47,060 46,092 22,159 5,225 2,605 Accrued Liabilities 22,122 Short-Term Borrowings Current Portion of Long-Term Debt & Capital Leases 5,257 4,405 Other Current Liabilities 428 645 Total Current Liabilities 77,477 78,521 Long-Term Debt & Capital Leases Deferred Income Taxes and Other 50,203 11,981 139,661 123,700 36,825 8,354 Total Liabilities EQUITY Common Stock and Paid-In Capital Retained Earnings Other Comprehensive Income (Loss) Total Common Equity Non-Controlling Interest Total Equity 3,253 2,943 80,785 85,107 (11,542) (10.181) 72,496 77,869 7,138 2,953 79634 80822 Total Liabilities & Equity 219.295 204.522
Transcribed Image Text:EXHIBIT 2: WALMART INC., CONSOLIDATED BALANCE SHEET AS OF JANUARY 31 ($ MILLIONS) 2019 2018 ASSETS Current Assets: Cash and Equivalents 7,722 6,756 Accounts Receivable 6,283 5,614 Inventory Prepaid Expenses Total Current Assets 44,269 43,783 3,623 3,511 61,897 59,664 Net Property, Plant & Equipment 111,395 114,818 Goodwill 31,181 18,242 Other Long-Term Assets 14,822 219.295 11,798 Total Assets 204.522 LIABILITIES Current Liabilities: Accounts Payable 47,060 46,092 22,159 5,225 2,605 Accrued Liabilities 22,122 Short-Term Borrowings Current Portion of Long-Term Debt & Capital Leases 5,257 4,405 Other Current Liabilities 428 645 Total Current Liabilities 77,477 78,521 Long-Term Debt & Capital Leases Deferred Income Taxes and Other 50,203 11,981 139,661 123,700 36,825 8,354 Total Liabilities EQUITY Common Stock and Paid-In Capital Retained Earnings Other Comprehensive Income (Loss) Total Common Equity Non-Controlling Interest Total Equity 3,253 2,943 80,785 85,107 (11,542) (10.181) 72,496 77,869 7,138 2,953 79634 80822 Total Liabilities & Equity 219.295 204.522
Dale: I think the reason we really care about the cost of capital is because we want to know what hurdle rate Walmart should use for its annual investments in capital projects, which represent billions of dollars each year. But I'm not sure if it should make any difference to senior management whether the company is investing in more U.S. stores, remodelling, or investing internationally. Shouldn't they want the same return? Lee: Dale: Interesting question. So, where should we start? I was thinking we might look at the balance sheet particularly the liabilities and equity section. Shouldn’t that show how Walmart financed its assets, which cost over $200 billion? Lee: Yes, and I think we should try to associate a cost with each of the items. Then we need to figure out how to average them in order to estimate the cost of capital. Dale: I think we need some kind of interest rate, or borrowing rate, for each of the debt components. Or maybe we can just take a look at how much interest the company paid last year relative to its debt? That might be easier. Lee: There sure are a lot of interest rates. I noticed on the U.S. Department of Treasury website that three-month treasury bills were yielding 2.45 per cent, while one-, five-, and 10-year treasury bonds were yielding 2.54 per cent, 2.47 per cent, and 2.65 per cent, respectively.“ I pulled together those and some other rates to graph today's yield curve compared with last year's (see Exhibit 1). I wonder if we can somehow use this information. Dale: I found some other interest rates as well. The prime rate is 5.50 per cent, and three-month commercial paper was averaging 2.73 per cent. I read in the annual report that Walmart has issued commercial paper in the past-as part of its short-term borrowings so perhaps that information might be relevant. I also read that Walmart uses short-term borrowing to provide funds for operations, make capital expenditures, and cover other cash requirements. Lee: Yes, and I read in the same report that Walmart has issued lots of bonds. Other reports showed the same pattern. For example, I noticed that on February 15, 2000, Walmart issued $1 billion in bonds with a coupon rate of 7.55 per cent. The bonds mature on February 15, 2030, around 11 years from now. I also noticed from an online source that these bonds were selling for $136.38 and yielding 3.53 per cent. I think I need to re-read the background material we were provided with because I'm confused about the difference between coupon rates and yields. Which is more relevant for us? Dale: What about preferred shares? I don't think Walmart has any currently, but I read that years ago it issued some kind of securities that were like preferred shares. I don't think the company has any plans to issue new preferred shares in the next little while, but maybe we should be prepared to figure out how it would affect the cost of capital if it did.
Transcribed Image Text:Dale: I think the reason we really care about the cost of capital is because we want to know what hurdle rate Walmart should use for its annual investments in capital projects, which represent billions of dollars each year. But I'm not sure if it should make any difference to senior management whether the company is investing in more U.S. stores, remodelling, or investing internationally. Shouldn't they want the same return? Lee: Dale: Interesting question. So, where should we start? I was thinking we might look at the balance sheet particularly the liabilities and equity section. Shouldn’t that show how Walmart financed its assets, which cost over $200 billion? Lee: Yes, and I think we should try to associate a cost with each of the items. Then we need to figure out how to average them in order to estimate the cost of capital. Dale: I think we need some kind of interest rate, or borrowing rate, for each of the debt components. Or maybe we can just take a look at how much interest the company paid last year relative to its debt? That might be easier. Lee: There sure are a lot of interest rates. I noticed on the U.S. Department of Treasury website that three-month treasury bills were yielding 2.45 per cent, while one-, five-, and 10-year treasury bonds were yielding 2.54 per cent, 2.47 per cent, and 2.65 per cent, respectively.“ I pulled together those and some other rates to graph today's yield curve compared with last year's (see Exhibit 1). I wonder if we can somehow use this information. Dale: I found some other interest rates as well. The prime rate is 5.50 per cent, and three-month commercial paper was averaging 2.73 per cent. I read in the annual report that Walmart has issued commercial paper in the past-as part of its short-term borrowings so perhaps that information might be relevant. I also read that Walmart uses short-term borrowing to provide funds for operations, make capital expenditures, and cover other cash requirements. Lee: Yes, and I read in the same report that Walmart has issued lots of bonds. Other reports showed the same pattern. For example, I noticed that on February 15, 2000, Walmart issued $1 billion in bonds with a coupon rate of 7.55 per cent. The bonds mature on February 15, 2030, around 11 years from now. I also noticed from an online source that these bonds were selling for $136.38 and yielding 3.53 per cent. I think I need to re-read the background material we were provided with because I'm confused about the difference between coupon rates and yields. Which is more relevant for us? Dale: What about preferred shares? I don't think Walmart has any currently, but I read that years ago it issued some kind of securities that were like preferred shares. I don't think the company has any plans to issue new preferred shares in the next little while, but maybe we should be prepared to figure out how it would affect the cost of capital if it did.
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