Estimating Walmart’s Cost of Capital Case Solution And Analysis, HBR Case Study Solution & Analysis of Harvard Case Studies

Estimating Walmart’s Cost of Capital Case Solution

Determination of cost of capital

The estimation of the cost of capital is all about making sure that the company is profitable for both investors as well as the owners. Given the choice of investment of equal risk; the estimation of the weighted average cost of capital is determined by the investors & generally the one providing higher returns is selected.

Estimation of cost of capital

The estimation of the weighted average cost of capital is based on cost of equity and cost of debt.The cost of equity is calculated with the use of the capital asset pricing model (CAPM Approach) because of various benefits, such as: it is one of the widely used methods to calculate the cost of equity, it is easier and simple to calculate and it equates the relationship between risk and rate of return in theoretical form. Additionally, it takes under consideration the level of the company’s systematic risk related to the stock market, which is generally left out by other methods, such as: dividend discount model. In the estimation of the cost of equity, the risk free rate of return is assumed to be the 10-year treasury constant maturity rate of 0.65 percent,because due to the reason that the 10-year government bond yield is long term bond and it embeds the expectation of inflation of long term debt.Whereas, the risk premium is assumed to be S&P500 annual rate of 13.49 percent. The adjusted beta is 0.71, which is better than raw beta due to the fact that the cost of equity calculated using raw beta, provides cost of equity without-the risk of debt, and it is an estimate of the future beta of security. Additionally, the raw beta in the cost of equity needs adjustments to better reflect the tendency of beta over longer period of time. Thus, the cost of equity is 12.2 percent.

On the other hand, the cost of debt is calculated through dividing the interest by the total liabilities. In 2019, the interest payment was 2129 million dollars; whereas, the total debt was 139661 million dollars, hence the cost of debt is 1.52 percent. The total debt included short term and long term liabilities of the company, due to the fact that the company uses short term debt to make capital expenditure, provide funds for operations as well as to cover other cash requirements. Additionally, the weight of debt and equity is 64 percent and 36 percent, respectively. Combining all these values in the formula, resulted in the weighted average cost of capital of 5.15 percent.

Usage of cost of capital

The estimation of the weighted average cost of capital could be used by the managers onthe basis of its annual investment in capital projects, which tends to represent billions of dollars each year. Furthermore, the calculation of the weighted average cost of capital provides a strong foundation of taking the capital budgeting decisions. Moreover, it would help the managers of the company to test whether the return on investment meets or exceeds an asset or cost of invested capital (debt and equity) of the company.

Difference between coupon rate and yield with relevancy

The coupon rate on bond issued by the company is the rate of interest which it tends to pay on an annual-basis; whereas, the bond yield refers to the rate of return it generates. The major differential points between coupon rate and coupon yield are listed below:

The coupons are fixed; no matter what bond and price trades are for, whereas the prices and yields are inversely related.
When the investor buys bond at the par value; the YTM is equal to the coupon rate, whereas if the bond is purchased at the discount; the YTM would be higher as compared to the coupon rate.
The rate of interest fluctuates the coupon rate; whereas, the bond yield tends to compare the coupon rate to the bond’s market price.

Impact of preferred shares on cost of capital

Based on how the relevant use of the common equity and debt is affecting; if the company issues the preferred shares, it would increase or decrease the weighted average cost of capitalof company on an immediate basis. If the company uses more preferred stock, there would be a reduction in its debt to equity ratio,lasting a positive impact over the firm, in the long run. The low financial leverage tends to reduce the overall risk and causes the cost of capital to go down with the passage of time. In contradiction, the increased use of the preferred stock relevant to the equity of company might expose the firm to high financial risk, due to the preferred-dividend obligations.(Way, 2017).

Evaluation of deferred income taxes

The deferred income taxes is the item of the balance sheet, which is resulted from the difference in recognition of income between tax laws and the accounting method of the company, due to which the payable income tax of the company might not equals to the tax expense reported. The most common cause of the deferred income tax is the significant difference in the methods of depreciation by the GAAP and IRS. It is because of the reason that the guidelines of GAAP allow the business to choose between the multiple practices of depreciation, however the IRS requires the use of depreciation method which is different from all the aforementioned available methods of GAAP......................

This is just a sample partial case solution. Please place the order on the website to order your own originally done case solution.

Estimating Walmart’s Cost of Capital Harvard Case Solution & Analysis