WAL-MART

Wal-Mart

Wal-Mart

Task I: Cost of Equity

Wal-Mart's capital structure consists of both Debt, and Equity. The following schedule is obtained from the company's annual report and lists the maturities as well as interest of Long-term Debt:

Equity is in the form of Common Stock shares that sell at a current price of $57.14, with a 52-week average selling price of $51.02. Last Year's annual dividend is $0.52, Growth Rate is expected to be 10.1% (Taken from the company's annual report), and therefore the cost of equity is approximately 1% The After Tax Cost of Debt (Both Short and Long term) is 1.4%, and the Tax Rate is 34.2%. The Weight of equity is 0.4, and the Weight of debt is 06. Therefore, the Weighted Average Cost of Capital is approximately 1.24%

Task II: Cost of Equity Analysis

Wal-Mart has a lower cost of equity than expected. The expected cost of equity is 10% while that for Wal-Mart is 1%. The cost of equity capital for a particular company is the rate of return on investment that is required by the company's ordinary shareholders. The return consists both of dividend and capital gains, e.g. increases in the share price. The returns are expected future returns, not historical returns, and so the returns on equity can be expressed as the anticipated dividends on the shares every year in perpetuity. The cost of equity is then the cost of capital which will equate the current market price of the share with the discounted value of all future dividends in perpetuity. The cost of equity reflects the opportunity cost of investment for individual shareholders. It will vary from company to company because of the differences in the business risk and financial or gearing risk of different companies.

The total volatility of a firm can be broken up into three pieces: financial leverage, operating leverage, and sales volatility. Saturday's piece dealt with financial leverage and its costs. An unlevered firm in the financial sense still possesses operating leverage and volatility of sales. Different unlevered firms have different costs of equity capital because they have different levels of sales volatility, and different degrees of operating leverage.

That will manifest itself in option implied volatility, which is a crude measure of what people would pay to gain and lose exposure to the equity of the company. The cost of equity should be positively related to that. More volatile companies should have a higher cost of equity.

The cost of equity should be higher than the cost of debt because in the case of bankruptcy, debt holders are repaid before equity holders, therefore decreased risk for debt. Debt is collateralised by the assets of the firm, equity is not.

Task III: Beta

We cannot directly observe beta in the market, instead it must be estimated. Traditionally, beta is estimated from a regression analysis that regresses historical returns from a stock against historical returns from some proxy index for the market. As a result, both the time period to regress returns over and the proxy you select will ...