Wal-Mart Cost of Capital

Wal-Mart, with $50 billion in sales in 2010 is the world's largest retailer. It operates nearly 2,000 Wal-Mart discount stores in the United States, approximately 200 Sam's Clubs membership-warehouse stores and a specialty distribution segment that serves 30,000 convenience stores and independent grocers. Discount store sales accounted for 73 percent of the 2010 sales. Membership club sales were the second-largest area accounting for 22 percent of 2010 sales. The remaining 5 percent of sales were accounted for by McLane and Western convenience store and independent grocer supply division. Thus, Wal-Mart was one of the companies that had resisted the trend toward diversifying far beyond their retailing base.

Concentration did not mean lack of growth, however. New capital expenditures were $3.5 billion plus an associated working capital investment of $1 billion. If Wal-Mart was to make optimal capital investment decisions, it was clear that an accurate estimate of cost of capital was required.

Wal-Mart presently had 1.15 billion shares of common stock outstanding. The stock has a beta of 0.84and sold for $60 per share in 2010. The market risk premium was 7.5 percent. The yield to maturity on U.S. Treasury bonds was 6.5 percent and treasury bills were selling to yield 3 percent in 2010. Based on dividends to date, dividends per share for 2011 were expected o be $0.13. Historical dividends per share and earnings per share were as follows:

Wal-Mart's balance sheet as of January 31, 2010 (the end of Walmart's fiscal year) summarizes the company's financial structure. Most of the company's debt was not actively traded. However, the company disclosed in a note to the financial statements that long-term debt with a book value of $3.576 billion had a fair market value of $3.859 billion. Assuming the average stated interest rate on outstanding securities was 6.5 percent, the yield to maturity would be 6.77percent. It was assumed that other long-term debt would sell at a similar yield to maturity if the debt were publicly sold.

Wal-Mart was a heavy user of commercial paper with an average daily balance outstanding for 2010 of $1.276 billion. The weighted average before-tax interest rate on this commercial paper was 2.86 percent.

Wal-Mart has $1.818 billion in capital lease obligations on the balance sheet. In the footnote there is a historical 7 to 14 percent imputed discount rate used in calculating this obligation. Given the overall decline in interest rates, the lower end of the range, or 7 percent, is probably the better estimate of what future leases will cost. Details of the long-term capitalized lease obligations and additional operating lease obligations are as follows:

The "thereafter" amount is assumed to be due at $443 million per year for the next 12 years from 2017 to 2028. The market rate of interest used to find the market value of these obligations is assumed to be 7 percent.

There were no shares of preferred stock outstanding. Wal-Mart has a 36% combined federal and state marginal tax rate in 2010.

Questions:

1) Estimate the market value and weight of each component of the capital structure.

2) Estimate the book value and weight of each component in the capital structure.

3) Estimate the required rate of return for each component of the capital structure.

4) Estimate the weighted average cost of capital for Wal-Mart using book values.

5) Estimate the weighted average cost of capital for Wal-Mart using market values.

6) Compare 4) and 5). In which area of the analysis is there the greatest potential for error? Why? Can anything be done to improve estimates in this area?