Financial Reporting, Financial Statement Analysis and Valuation
Financial Reporting, Financial Statement Analysis and Valuation
8th Edition
ISBN: 9781285190907
Author: James M. Wahlen, Stephen P. Baginski, Mark Bradshaw
Publisher: Cengage Learning
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Chapter 11, Problem 14PC

Problem 10.16 projected financial statements for Walmart for Years +1 through +5. The following data for Walmart include the actual amounts for 2012 and the projected amounts for Years +1 through +5 for comprehensive income and common shareholders’ equity, assuming it will use implied dividends as the financial flexible account to balance the balance sheet (amounts in millions).

Chapter 11, Problem 14PC, Problem 10.16 projected financial statements for Walmart for Years +1 through +5. The following data

Assume that the market equity beta for Walmart at the end of 2012 was 1.00. Assume that the risk-free interest rate was 3.0% and the market risk premium was 6.0%. Also assume that Walmart had 3,314 million shares outstanding at the end of 2012, and share price was $69.09.

REQUIRED

  1. a. Use the CAPM to compute the required rate of return on common equity capital for Walmart.
  2. b. Compute the weighted-average cost of capital for Walmart as of the start of Year +1. At the end of 2012, Walmart had $48,222 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, it will incur interest expense of 4.2% on debt capital and that its average tax rate will be 32.0%. Walmart also had $5,395 million in equity capital from noncontrolling interests. Assume that this equity capital carries a 15.0% required rate of return. (For our forecasts, we assume noncontrolling interests are similar to preferred shares and receive dividends equal to the required rate of return each year.)
  3. c. Use the clean surplus accounting approach to derive the projected dividends for common shareholders for Years +1 through +5 based on the projected comprehensive income and shareholders’ equity amounts. (Throughout this problem, you can ignore dividends to noncontrolling interests.)
  4. d. Use the clean surplus accounting approach to project the continuing dividend to common shareholders in Year +6. Assume that the steady-state long-run growth rate will be 3% in Years +6 and beyond.
  5. e. Using the required rate of return on common equity from Requirement a as a discount rate, compute the sum of the present value of dividends to common shareholders for Walmart for Years +1 through +5.
  6. f. Using the required rate of return on common equity from Requirement a as a discount rate and the long-run growth rate from Requirement d, compute the continuing value of Walmart as of the beginning of Year +6 based on its continuing dividends in Years +6 and beyond. After computing continuing value, bring continuing value back to present value at the start of Year +1.
  7. g. Compute the value of a share of Walmart common stock, as follows:
    1. (1) Compute the sum of the present value of dividends including the present value of continuing value.
    2. (2) Adjust the sum of the present value using the midyear discounting adjustment factor.
    3. (3) Compute the per-share value estimate.
  8. h. Using the same set of forecast assumptions as before, recompute the value of Walmart shares under two alternative scenarios. To quantify the sensitivity of your share value estimate 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 Requirement g.
    • Scenario 1: Assume that Walmart’s long-run growth will be 2%, not 3% as before, and assume that its required rate of return on equity is 1 percentage point higher than the rate you computed using the CAPM in Requirement a.
    • Scenario 2: Assume that Walmart’s long-run growth will be 4%, not 3% as before, and assume that its required rate of return on equity is 1 percentage point lower than the rate you computed using the CAPM in Requirement a.
  9. 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?
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Chapter 12, Question 10b: You need to estimate the equity cost of capital for XYZ Corp. You have the following data available regarding past returns: Year Risk-free Return 2007 3% 2008 1% Market Return XYZ Return 6% 10% -37% -45% Part B Estimate XYZ's beta (Hint: You'd better compute the market's and XYZ's excess returns for each year to proceed) beta = 1.17 beta 1.35 beta = 1.11 Obeta = 1.29
Subject: Financial strategy & policy Question No 3   (part i)                                                                            Answer the following. i) The future earnings, dividends, and common stock price of Nabeel Inc. are expected to grow 7% per year. Common stock currently sells for $23.00 per share; its last dividend was $2.00. a) Using the DCF approach, what is its cost of common equity? b) If the firm’s beta is 1.6, the risk-free rate is 9%, and the average return on the market is 13%, what will be the firm’s cost of common equity using the CAPM approach? c) If the firm’s bonds earn a return of 12%, based on the bond-yield-plus-risk-premium approach, what will be rs? d) If you have equal confidence in the inputs used for the three approaches, what is your estimate of cost of common equity?
Question 4  Suppose that the consensus forecast of security analysts of your favorite company is that earnings next year will be E1 = $5.00 per share. Suppose that the company tends to plow back 50% of its earnings and pay the rest as dividends. If the Chief Financial Officer (CFO) estimates that the company’s growth rate will be 8% from now onwards, answer the following questions.  a) If your estimate of the company’s required rate of return on its stock is 10%, what is the equilibrium price of the stock?  b) Suppose you observe that the stock is selling for $50.00 per share, and that this is the best estimate of its equilibrium price. What would you conclude about either (i) your estimate of the stock’s required rate of return; or (ii) the CFO’s estimate of the company’s future growth rate?  c) Suppose your own 10% estimate of the stock’s required rate of return is shared by the rest of the market. What does the market price of $50.00 per share imply about the market’s estimate of…
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