W19208
ESTIMATING WALMART’S COST OF CAPITAL 1
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Copyright © 2019, Ivey Business School Foundation
Version: 2019-05-17
OVERVIEW
In March 2019, Dale and Lee, senior managers from technology firms, were attending an executive
education program—Financial Management for Non-Financial Executives—at a highly-regarded business
school. They were provided with background readings related to estimating a firm’s cost of capital. Their
small-group learning team was assigned the task of applying the learnings from the readings and
gathering background information related to Walmart Inc. (Walmart) in order to estimate its costs of
capital (see Exhibits 1 to 5). The following day, they would participate in a class discussion, share their
results, and discuss why the cost of capital was such an important concept.
Walmart had humble beginnings: Sam Walton opened the first Walmart store in 1962 in Rogers,
Arkansas.2 Subsequently, Walmart grew to be the world’s largest retail store, serving 275 million
customers weekly from more than 11,300 stores and numerous e-commerce websites under 58 banners in
27 countries. 3 Walmart’s goal was to help people around the world save money and live better, and its
strategy was to make every day easier for busy families, operate with discipline, sharpen its culture and
become digital, and make trust a competitive advantage. 4 In the fiscal year ending January 31, 2019,
Walmart had invested over $10 billion in capital expenditures: over $300 million on new stores in the
United States; over $2 billion on remodelling; over $5 billion on e-commerce, technology, and supply
chain; and $2.7 billion internationally. 5
ESTIMATING THE COST OF CAPITAL
Dale and Lee sat down with the information that had been gathered and discussed the task—how they
would estimate the cost of capital, and why it was important.
1
This case has been written on the basis of published sources only. Consequently, the interpretation and perspectives
presented in this case are not necessarily those of Walmart Inc. or any of its employees.
2
Walmart Inc., 2019 Annual Report, 7, accessed April 30, 2019, https://s2.q4cdn.com/056532643/files/doc_financials/2019/
annual/Walmart-2019-AR-Final.pdf.
3
Ibid.
4
Ibid.
5
Ibid., 33; All currency in US dollars.
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Dale:
I think the reason we really care about the cost of capital is because we want to know what hurdle
rate Walmart should use for its annual investments in capital projects, which represent billions of
dollars each year.
Lee:
But I’m not sure if it should make any difference to senior management whether the company is
investing in more U.S. stores, remodelling, or investing internationally. Shouldn’t they want the
same return?
Dale:
Interesting question. So, where should we start? I was thinking we might look at the balance
sheet—particularly the liabilities and equity section. Shouldn’t that show how Walmart financed
its assets, which cost over $200 billion?
Lee:
Yes, and I think we should try to associate a cost with each of the items. Then we need to figure
out how to average them in order to estimate the cost of capital.
Dale:
I think we need some kind of interest rate, or borrowing rate, for each of the debt components. Or
maybe we can just take a look at how much interest the company paid last year relative to its
debt? That might be easier.
Lee:
There sure are a lot of interest rates. I noticed on the U.S. Department of Treasury website that
three-month treasury bills were yielding 2.45 per cent, while one-, five-, and 10-year treasury
bonds were yielding 2.54 per cent, 2.47 per cent, and 2.65 per cent, respectively. 6 I pulled
together those and some other rates to graph today’s yield curve compared with last year’s (see
Exhibit 1). I wonder if we can somehow use this information.
Dale:
I found some other interest rates as well. The prime rate is 5.50 per cent, and three-month
commercial paper was averaging 2.73 per cent. I read in the annual report that Walmart has
issued commercial paper in the past—as part of its short-term borrowings—so perhaps that
information might be relevant. I also read that Walmart uses short-term borrowing to provide
funds for operations, make capital expenditures, and cover other cash requirements.
Lee:
Yes, and I read in the same report that Walmart has issued lots of bonds. Other reports showed
the same pattern. For example, I noticed that on February 15, 2000, Walmart issued $1 billion in
bonds with a coupon rate of 7.55 per cent. The bonds mature on February 15, 2030, around 11
years from now. I also noticed from an online source that these bonds were selling for $136.38
and yielding 3.53 per cent. I think I need to re-read the background material we were provided
with because I’m confused about the difference between coupon rates and yields. Which is more
relevant for us?
Dale:
What about preferred shares? I don’t think Walmart has any currently, but I read that years ago it
issued some kind of securities that were like preferred shares. I don’t think the company has any
plans to issue new preferred shares in the next little while, but maybe we should be prepared to
figure out how it would affect the cost of capital if it did.
Lee:
How should we go about estimating the cost of equity?
6
U.S. Department of Treasury, “Resource Center: Daily Treasury Yield Curve Rates,” accessed February 19, 2019,
www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.
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Dale:
I think, since shareholder return is in the form of dividends that shareholders receive, we could
examine the annual dividends relative to the current stock price. Over the past year, shareholders
received $2.08 per share in dividends. The stock was recently trading for $102.20.
Lee:
I think earnings are more relevant than dividends. Earnings were down recently because of
several one-time write-offs, at the end of the last fiscal year. Walmart recorded $2.26 in
unadjusted earnings per share, but $4.91 in adjusted earnings per share. So why not take the
earnings yield relative to the stock price?
Dale:
I wonder if we can estimate an equity return using accounting information such as the book value
of equity. I estimated Walmart’s return on equity or ROE to be 8.9 per cent as of the fiscal year
ending January 31, 2019. For 2018, 2017, and 2016, it was 12.7, 17.2, and 18.1 per cent,
respectively.
Lee:
But that includes retained earnings. Aren’t those like free capital—and therefore something we can
ignore?
Dale:
Maybe we’re overlooking something; there may be a different approach. Recall that we read
about the beta of a stock. It is usually estimated by regressing the return on a stock, like Walmart,
against the return on the market, like the S&P 500. According to the Bloomberg terminal we
accessed in our library, Walmart’s recent “raw” beta was 0.56. It was based on a regression of
two years of weekly data.
Lee:
I noticed that as well. There was also an “adjusted” beta of 0.71. According to Bloomberg, the ad
hoc adjustment—0.67 times the raw beta plus 0.33—always makes the adjusted beta closer to the
market’s beta of 1.0. They do this because of the assumption that a security’s beta tends to move
toward the market average over time.
Dale:
Well, I think if we try to incorporate Walmart’s beta, then we need to somehow take into account
overall market returns.
Lee:
We also need to incorporate taxes. I’m not sure how we go about doing that. But I also noticed in
the business news that corporate tax rates are now lower than in the recent past due to some new
U.S. tax regulations. I read that the new rate is 21 per cent. But a recent press release to
accompany Walmart’s quarterly returns says the company is anticipating an effective tax rate of
around 27 per cent.
Dale:
What about deferred income taxes? I remember reading that these can arise when a company is
allowed to depreciate its assets at a faster rate, for tax purposes, than the actual economic
depreciation. Is that money that needs to be paid back to the tax department? If so, what cost is
associated with it?
Lee:
I’m not sure. I also noticed there are other items on the balance sheet under “Liabilities and
Equity,” and I’m not even sure what they mean.
Dale:
I may have figured them out: “Other Non-Current Liabilities”—which is lumped in with
“Deferred Income Taxes” and is probably about half that total—may have to do with some
unrealized losses on hedging instruments. “Other Comprehensive Loss” was related to foreign
exchange losses, with the U.S. dollar stronger relative to other currencies. And “Non-Controlling
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Interest” adjusts for subsidiaries that Walmart has a majority stake in. I think we can ignore all of
those items.
Lee:
It’s getting late, and we haven’t even talked about how we would estimate the weights for the
various sources of capital. I’m wondering if we should just look at the balance sheet for clues. Or
maybe there’s another way.
Dale:
I’m not sure if it even makes sense to take an average. Shouldn’t we just look at the next source
of financing? For example, if Walmart borrows or issues bonds just before taking on its next
major project, then shouldn’t we just take the cost associated with that?
Lee:
Well, I think we’ve now come full circle. Once we estimate the cost of capital, how do we
determine what hurdle rate we should use for projects? And how should Walmart decide which
projects to accept: using the net present value approach or the internal rate of return method?
Dale:
I don’t think it matters. But I do think we need to try to put this all together soon so that we get a
final number and explain how we arrived at it!
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EXHIBIT 1: U.S. TREASURY YIELDS
Source: Created by the case author using data from U.S. Department of Treasury, “Resource Center: Daily Treasury Yield
Curve
Rates,”
accessed
February
19,
2019,
www.treasury.gov/resource-center/data-chart-center/interestrates/Pages/TextView.aspx?data=yield.
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EXHIBIT 2: WALMART INC., CONSOLIDATED BALANCE SHEET
AS OF JANUARY 31 ($ MILLIONS)
2019
2018
7,722
6,283
44,269
3,623
61,897
6,756
5,614
43,783
3,511
59,664
111,395
31,181
14,822
219,295
114,818
18,242
11,798
204,522
47,060
22,159
5,225
2,605
428
77,477
46,092
22,122
5,257
4,405
645
78,521
Long-Term Debt & Capital Leases
Deferred Income Taxes and Other
Total Liabilities
50,203
11,981
139,661
36,825
8,354
123,700
EQUITY
Common Stock and Paid-In Capital
Retained Earnings
Other Comprehensive Income (Loss)
Total Common Equity
Non-Controlling Interest
Total Equity
3,253
80,785
(11,542)
72,496
7,138
79,634
2,943
85,107
(10,181)
77,869
2,953
80,822
Total Liabilities & Equity
219,295
204,522
ASSETS
Current Assets:
Cash and Equivalents
Accounts Receivable
Inventory
Prepaid Expenses
Total Current Assets
Net Property, Plant & Equipment
Goodwill
Other Long-Term Assets
Total Assets
LIABILITIES
Current Liabilities:
Accounts Payable
Accrued Liabilities
Short-Term Borrowings
Current Portion of Long-Term Debt & Capital Leases
Other Current Liabilities
Total Current Liabilities
Note: This balance sheet was simplified somewhat for ease of discussion. As of this date there were approximately 2,945
million shares outstanding.
Source: Created by the case author using data from Walmart Inc., 2019 Annual Report, 7, accessed April 30, 2019,
https://s2.q4cdn.com/056532643/files/doc_financials/2019/annual/Walmart-2019-AR-Final.pdf.
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EXHIBIT 3: WALMART INC., CONSOLIDATED INCOME STATEMENT
AS OF JANUARY 31 ($ MILLIONS)
Revenue
Costs and Expenses:
Cost of Goods Sold
Operating, Selling, General & Administrative Expenses
Total Costs and Expenses
Operating Income
Interest Expense, Net
Other Items
Income Before Income Taxes
Income Tax Expense
Net Income
Net Income Attrributable to Non-Controlling Interests
Net Income Attributable to Walmart Shareholders
2019
2018
514,405
500,343
385,301
107,147
492,448
21,957
373,396
106,510
479,906
20,437
(2,129)
(8,368)
11,460
(2,178)
(3,136)
15,123
4,281
7,179
(509)
6,670
4,600
10,523
(661)
9,862
Note: This income statement was simplified somewhat for ease of discussion.
Source: Created by the case author using data from Walmart Inc., 2019 Annual Report, 7, accessed April 30, 2019,
https://s2.q4cdn.com/056532643/files/doc_financials/2019/annual/Walmart-2019-AR-Final.pdf.
EXHIBIT 4: SELECTED DATA ON WALMART INC., 2007–2019
Year
EPS
DPS
Stock
Price
Total
Return
2007
2.71
0.67
36.30
10.07%
2008
3.12
0.88
37.98
7.04%
2009
3.39
0.95
38.36
3.52%
2010
3.71
1.09
43.04
15.03%
2011
4.47
1.21
42.33
1.15%
2012
4.52
1.46
49.43
20.22%
2013
5.02
1.59
60.68
25.97%
2014
4.88
1.88
65.61
11.23%
2015
5.06
1.92
75.56
18.10%
2016
4.58
1.96
61.39
-16.17%
2017
4.39
2.00
67.54
13.28%
2018
3.27
2.04
87.92
33.20%
2019
2.28
2.08
96.08
11.64%
Notes: As at fiscal year-end, January 31; EPS = earnings per share; DPS = dividends per share; Total Return = (Dividend +
Price Change) ÷ Previous Price.
Source: Created by the case author using dividend and stock price data from “Walmart Inc. (WMT),” Yahoo! Finance,
accessed February 20, 2019, https://finance.yahoo.com/quote/WMT/; and earnings data from “Walmart EPS Diluted (TTM):
2.28 for Jan. 31, 2019,” YCharts, accessed February 20, 2019, https://ycharts.com/companies/WMT/eps_ttm.
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EXHIBIT 5: AVERAGE ANNUAL RETURNS IN U.S. CAPITAL MARKETS
OVER THE PERIOD 1928–2018
Arithmetic Average
1928-2018
1969-2018
2009-2018
Geometric Average
1928-2018
1969-2018
2009-2018
S&P 500
(Includes
Dividends)
3-Month
Treasury Bill
Return on 10Year Treasury
Bond
11.36%
11.10%
13.49%
3.43%
4.76%
0.49%
5.10%
7.10%
2.28%
9.49%
9.73%
12.98%
3.38%
4.71%
0.49%
4.83%
6.69%
1.97%
Source: Created by the case author using data from Aswath Damodaran, “Annual Returns on Stock, T.Bonds and T.Bills:
1928–Current,” Aswath Damodaran (blog), accessed February 19, 2019, http://people.stern.nyu.edu/adamodar/New_Home
_Page/datafile/histretSP.html.
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