cost of Capital of Wal-Ma, ne A Financial Analysis Presented by: Cynthia N. Galvan & Laura Muniz CSU Fullerton Prof. Yun Park FIN 332 Dec. 7, 2006Executive Summary This report examines Wal-Mart's financial situation. The purpose of this report is to determine the cost of capital of Wal-Mart by using the capital asset pricing model. Wal-Mart was established in 1962 in Rogers, Arkansas by Sam Walton. It started as a neighborhood store but it slowly gained enough capital and in 1970 its stock became ible in the New York Stock Exchange. Wal-Mart is now one of the largest and most successful discount stores worldwide. Wal-Mart employs 1.8 million people worldwide. ‘The finance.yahoo.com website was used throughout this report. The website was used to retrieve the financial statements as well as the historical prices for Wal-Mart and S&P500. With the help of this website we calculated the monthly returns for both companies. We then used the returns to run a regression and found Beta to be .5739 or 57%. We figured cost of capital to be 7.72 and cost of debt is 3.64. Weighted Average Cost of Capital estimated to be 7.0377. Company Introduction The first Wal-Mart was founded in 1962 in Rogers, Arkansas by Sam Walton. Wal-Mart Stores, Inc. operates retail stores in various formats worldwide. It operates in two types of segments, Wal-Mart stores and SAM’S CLUB. The Wal-Mart Stores consist of super centers, discount stores, and neighborhood markets. It also operates through the internet at Walmart.com. Wal-Mart Stores sell items such as apparel for the entire family, domestics, fabrics, books, shoes, house wares, hardware, electronics, home furnishings, small appliances, health and beauty aids, automotive services, automotive accessories, etc. Wal-Mart Stores are very common in California. The neighborhood markets include dry grocery, meat products, deli, bakery, dairy, frozen foods, pharmaceuticals, photoprocessing, health and beauty aids, household chemicals, paper goods, general merchandise, and pet supplies. SAM’S CLUB is mainly operated by offering its membership to the public. It also operates online at samsclub.com, SAM’S CLUB offers software, electronics, jewelry, sporting goods, toys, tires, stationery and books, grocery items, and selected private labels, As of January 31, 2006, the company operated 1,209 discount stores, 1,980 super centers, 567 SAM'S clubs, and 100 neighborhood markets in the United States and internationally. It also operated 11 units in Argentina, 295 in Brazil, 278 in Canada, 88 in Germany, 398 in Japan, 774 in Mexico, 54 in Puerto Rico, 16 in South Korea, and 315 in the United Kingdom, as well as 56 stores through joint ventures in China. Wal-Mart is the nation’s largest private employer and a leading employer of minorities; with more than 225,000 African American associates; more than 150,000 Hispanic associates; and more than 240,000 seniors who are 55 or older. Wal-Mart employs 1.8 million associates worldwide, including 1.3 million in the United States. Wal-Mart has created more than 240,000 new jobs over the past three years in the U.S Wal-Mart is famous for its Roll Back Prices and competitive low prices. According to an independently-certified study, Wal-Mart saves the average American household more than $2,300 per year. There is no doubt that Wal-Mart is one of the most competitive companies that allows for its customers to obtain name known products at an incredible low price!Cost of Debt In order to solve for the cost of debt we used the 10-year maturity AAA investment grade corporate bond yield of 5.44% as quoted at finance.yahoo.com as of November 22, 2006. To estimate the company’s tax rate, we divided the income tax expense of 2006: $5,803,000, by the income before tax of 2006: $17,358,000. The tax rate calculated is 0.33 shown in Exhibit #2. Our calculation for the firm’s after-tax cost of debt is about 3.648%. The analysis of the cost of debt is summarized in Exhibit #1. Cost of Common Equity To estimate the cost of common equity, we used the Capital Asset Pricing Model, For the risk free rate we used the 10-year Treasury bond index value of 4.5680% quoted from finance.yahoo.com as of November 22, 2006. We estimated the market risk premium to be 5.5 % given that the historical market risk premium has been between 5% to 6%. We arrived at the cost of common equity for Home Depot by multiplying the beta of 5739 by the historical market risk premium of 5.5%, and then added this amount to the risk free rate of 4.5680%. The cost of common equity is 7.7245%. The estimation of the cost of common equity of Wal-Mart using the CAPM model is summarized in Exhibit #3. Beta Estimation We arrived at beta estimate for Wal-Mart of .5739 using regression analyses of the past 60 months for Wal-Mart and industry S&P 500. Wal-Mart’s beta is fairly lower than 1, which is below the market’s beta, Wal-Mart's historical prices and returns as well as the corresponding historical prices and returns of S&P 500 were used to perform theregression analysis summarized in Exhibit #4. This allowed use to move forward and finish calculating Wal-Mart's cost of equity. 3. Cost of Preferred Stock Wal-Mart does not have any outstanding preferred stock, or paid preferred dividend. The company does not finance through preferred stocks. 5. Weighted Average Cost of Capital (WACC) To estimate the weighted average cost of capital, we used the cost of equity of 7.7245% and the cost of debt of 3.6448%. We calculated the weight of debt to be 13% and the weight of equity to be 87%. For the weight of debt we divided Long Term Debt reported in the liabilities section of Wal-Mart’s 2006 balance sheet by the sum of debt and equity. We used Wal-Mart's Market Cap for the sum of equity, multiplying the number of outstanding shares by the closing price presented in Exhibit #6. For the weight of equity (Market Cap) we divided equity (Market Cap) by the sum of debt and equity (Market, Cap). Wal-Mart's estimated cost of capital is 7.037% or 7% presented in Exhibit #5.EXHIBIT #1 COST OF DEBT FINANCING Kd AT =KdBT(I-T) =5.44(1-.33) =3.6448 T TAX RATE 0.33 (6,803,000 / 17,358,000) Kd or PRE TAX COST OF DEBT 5.44 Corporate Bonds Maturity Yield Yesterday Last Week Last Month 2yr AA 5.06 5.08 5.16 $32 2yrA 5105.14 5.21 5.38 Syr AAA 5.06 5.10 3.17 5.32 Syr AA 5.10 5.12 5.18 539 Syr A 518 5.19 5.24 5.47 10yr AAA. 5445.47 5.57 5.71 lyr AA 531 5.33 5.39 5.63 loyr A 540 5.40 3.44 3.70 20yr AAA S96" -5.77. 5.80 5.96 20yr AA, 5.99 5.98 6.01 6.02 20yr A 584 5.84 5.87 6.12EXHIBIT #2 WALMART Income Statement and Balance Sheet Income Statement ait numbers in thousands PERIOD ENDING StJan-06 — S1-Jan05 34-Jan-04 Total Revenue 318,654,000 989,000 258,681,000 Cost of Revenue 240,391,000 219,793,000 _ 198,747,000 Gross Profit 75,263,000 68,196,000 $9,834,000 Operating Expenses evelopment . : ening wenerai ano Administrative 58,733,000 51,105,000 44,909,000 Non Recurring : S others ‘ora Uperaung Expenses : i ‘Operating Income or Loss 18,530,000 17,081,000 15,025,000 Income from Continuing Operations IncomerExpenses Net 243000 201,000 164,000 Earnings werore Interest And Taxes 1878.00 17,282,000 18,189,000 Interest Expense 4420000 1,187,000 996,000, Income Before Tax 16,105,000 14,193,000 Expense 5589,000 5,118,000 Minority interest 324000 -249.000--214,000 Continuing Ops 11,231,000 10,287,000 8,861,000 Nonecurring Events Operations : = 193,000 Extraordinary tems a ‘seer ur Aetounong Changes ; : : ther tems Net income 11,231,000 10,267,000 9,054,000 Preferred Stock And Other Adjustments - - ‘Shares $11,231,000 $10,267,000 $9,054,000 TAX RATE 0.33 (income tax expense/income before tax)EXHIBIT #2 WALMART Balance Sheéacome Statement and Balance Shee, Al numbers in thousands PERIOD ENDING SJon-06 Stan 03-Jan-04 Assets Curent Assets , Equvaions 6.416000 5,488,000 5,199,000 investments - : NetReceivables 252.000 1,715,000 1,254,000, ‘ey 32,101,000 29,447,000 26,612,000 257,000 1,841,000 1,356,000 EEE Total Current Assets 43824000 38,491,000 34421,000, Long Term investments : : Property Piant and Equipment 79200,000 68,567,000 58,530,000 Goodwit 12,188,000 10,803,000 9.882.000 Intangbie Assets : Accumulated Amortization Other Assets 2885,000 2362000 2079000 Deferred Long Term Asset Charges a Total Assets 138,187,000 120,223,000 104,912,000, LUsbitties Curren Lisbilties Accounts Payable 40.178,000 36,107,000 31,051,000 Shorwcurent wong Tem Debt ‘3648.00 7.781.000 6.267000 abites = a a Labiies 48,826,000 42,888,000 27,418,000 Long Term Debt [WsoirHeG—] 22,660.00 20,088.000 tne Libis ~ Defered Long Term Lisbity Charges 552.000 2.947.000 2.288000 Minty interest 1467000 1323000 1484,000 Negative Goodwil EES SS Lisilties 185,016,000 70,827,000 ‘Stockholders’ Equity Mise Stocks Options Warrants : : Redeemable Prefered Stock : : Prater Stock : : Common Stock 417000 423000 431,000 Retained Eamings 48,105.00 43,884,000 40,206,000 “Treasury Stock : Capital Surpius 2896,000 2.425.000 2.13500 Other Stockholder Equity 1,053,000 2.694.000 851,000 Ee Total Stockholder Equity 53,171,000 49,306,000 43,623,000 Not Tangible Assets {$40,983,000 $38,583,000 $33,741,000,EXHIBIT #3 COST OF EQUITY CAPITAL ASSET PRICING MODEL (CAPM) K(s) = K(rf) + B(RP) | =4,5680 + 5739(5.5) I =2.7245, VALUATION DATE 1122/2006 K(f) RISK FREE RATE 4.5680 10-YEAR TREASURY NOTE «ce: oeeyes aust dete Index Value 4.5680 ‘Trade Time: tt0aM ET change $0.0100,0.22%) Prev Close 4578 Open: 458 Days Range 4.5600 -4 5800 4d Sd 3m ony 2 5 max ‘52k Range: 4209-5245, RP RISK PREMIUM 55% |B BETA 5739tseziz000 zes01 ¥2681950°0- sees s¥s920500 sozze3r+0'0- wis zve1z1i00 zeazsisi00 zz o60zzt00 ‘yr606501'0 vous ‘ye9se9100- 962015%00'0 eus e0619100- zu1z05¥0°0- ers Sresozio' 1660369610 0- 6h¥s 906962100 ‘s089z18500° wis zsoszvco'0- 19529626000 wis cez9zz00°0 ‘s05920%000" ers eese600'0 azsoct0100 seis Szriorio0 zevo0se100 soz ‘yeves9e0 0 secervreo0- 205 erssvzc00 es16r69100 ois sroszsz00- ‘scesr6L000- eris ‘8e0068100 zv0si00- zv0s SLi16100- 80081920'0- ver ess010z00- zosaszeso'o- ero zo2s66200 1065615000 evor s9zr10000- ‘s0sosr0z0'0 eeu zessscoo si vezi szvevatzoo iser eozzziioo- ccozet 919900- eer ‘yeave0000 189zzt esosezszo0- weer ‘0"12100- 102021 4021196200 soov zigaiseoo evere ess9erz0'0 our ‘wes60000° 6z v2 zosozeco'o- exer ve997s200 900021 8686990 10'0- ir te9r000°0 99.0821 zauerro100- sev vesso1100 Ze ¥6zi Ligvzvs¥00 69r sessizioo s9oier Ste8069%0'0- Lew 9160800- soozzt zuuse96100 ze So-avove8 zovzt ‘yox008800'0- eer ese0s00'0 99'9221 eeessz9100- scr sevzi200 ze 0c! 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