Question

Walmart, America’s largest retailer had the market’s second largest debt issuance in the U.S. in 2019, selling $16 billion in 30 year bonds. The funds were to help finance the purchase of Flipkart, India’s largest online seller. Thanks to Walmart’s high credit rating, the bonds were classified by Moody’s (one of the top bond rating agencies) as Aa2, or very highly rated. The bond sale was managed by a syndicate of investment banks, including Barclays Plc, Citigroup Inc., JPMorgan Chase & Co., Bank of America Corp., HSBC Holdings Plc and Wells Fargo & Co.

Data for Walmart as of April 2019

Market Price	$103.18
# Shares (mm, or millions)	2,897
Long term debt ($mm from balance sheet)	$45,396
Tax rate (T)	25%
Walmart beta (β)	0.66
Current risk free rate (rf)	2.59%
Estimated market risk premium	6.00%
Estimated underwriter spread	1.0%
Estimated additional flotation costs	0.5%
Estimated total flotation cost (as a % of debt face value)	1.50%

WalMart data to use	2015	2016	2017	2018	2019
Dividend payout ratio (dividends paid out as a % of net income)	38.02%	42.89%	45.59%	62.04%	91.68%
Net income ($ millions)	$16363	$14694	$13643	$9862	6670
Common equity $ (millions, book value)	$85937	$83611	$80535	$80822	79634
ROE (net income/common equity or NI/CE)	19.04%	17.57%	16.94%	12.20%	8.38%
	2015	2016	2017	2018	2019
Dividend history ($/share)	$1.91	$1.96	$2.00	$2.04	$2.08
		2020	2021	2022	2023
Dividend estimates ($/share)		$2.14	$2.05	$2.40	$2.48

Basic “starting point” data:

You are to calculate each of the following based on the data provided above.

1)	Value of equity (market capitalization)	298912.46
2)	Value of long term debt (use book value as given)	$45,396
3)	Weight of equity	0.868
4)	Weight of debt	0.132

Need help with the questions below based on the information above:

  5. What is the 3 year growth rate (2020-2023) of expected dividends?

6. What is the 4 year growth rate (2015-2019) of actual dividends?

7. DISCUSS: Do either of these values seem appropriate? If so, which one and why?

8. What are the difficulties in estimating the "constant" growth rate for Walmart using the firm's ROE and payout ratio? [g = ROE*(1-payout ratio]

9. Using the CAPM equation for the required cost of capital, r = rf + β(market risk premium), what is the required cost of equity (r_e)?

10. What is the adjusted pre-tax cost of debt (r_d)?

Answer 1

2897*103.18=	298912.46	Mlns.
Debt ($)	45396
298912.46/(298912.46+45396)	0.868	Wt. E
45396/(298912.46+45396)=	0.132	Wt. D

$ dividends (as given above)	1.91	1.96	2	2.04	2.08	2.14	2.05	2.4	2.48
Growth in $ dividends over the previous yr.		2.62%	2.04%	2.00%	1.96%		-4.21%	17.07%	3.33%
5...3-Year growth rate of expected div.(2020-2023 div.)/Av.3									5.40%
6...4-Year growth rate of actual div.(2015-2019 div.)/Av.4					2.15%

7...4-year growth rate of actual dividends seems appropriate as there are no wide variations in $ dividends & there is consistent positive growth.

8.Difficulties in estimating the "constant" growth rate for Walmart using the firm's ROE and payout ratio

From the above- given data, even thugh $ dividends are known, net income to arrive at the retention ratio after 2019 are not known.

9...Required Cost of equity as per CAPM

Ke=RFR+(Beta*MRP)

ie. 2.59%+(0.66*6%)=

6.55%

10.Pre-tax cost of debt=3.85%
After-tax cost of debt=3.85%*(1-25%)=
2.89%
11.WACC=(Wt.E*Ke)+(Wt.d*Kd)=
WACC=(0.868*6.55%)+(0.132*2.89%)=
6.07%
This WACC may not be suitable for more-of-debt funding projects --where costs may be higher.
. ie. One WACC cannot suit all requirements: if there is a drastic change in the capital structure , as in the case of Walmart, where at present ,it has more of equity(86.8%) & very less of debt(13.2%), the WACC calculated may not meet the new-risk profile-,as is always the case with outside funding. In such cases , WACC has to be adjusted for the additional risk.

Workings for 5 & 6	2015	2016	2017	2018	2019	2020	2021	2022	2024
$ dividends (as given above)	1.91	1.96	2	2.04	2.08	2.14	2.05	2.4	2.48
Calculation for growth % (Current dividend-Previous dividend))/Previous dividend)
Growth in $ dividends over the previous yr.(above formula)		2.62%	2.04%	2.00%	1.96%		-4.21%	17.07%	3.33%
5...3-Year growth rate of expected div.(2020-2023 div.)/Av.3---(Sum of 3 yrs.' growth %/3)									5.40%
6...4-Year growth rate of actual div.(2015-2019 div.)/Av.4---(Sum of 4yrs.' growth %/3)					2.15%
Answers:
5…. 5.40%
6…..2.15%