Question

CALCULATE THE COST OF DEBT;

Walmart has at least 50 long-term bonds, the weighted average yield on these bonds is 3.2%. On the other hand, a simplified cost of debt can be calculated as the interest expenses divided by two year average of book value of debt. For Walmart, the book and market value of debt is nearly identical. This estimated cost of debt is 4.49%.

For our purposes, we will take the average, and use 3.85% as the pre-tax cost of debt (preliminary).

Now that we have the average pre-tax cost of debt, we need to account for the underwriter spread. We are simplifying from flotation costs calculated for equity. The adjusted pre-tax cost of debt should be estimated rate (from above)/(1-UW spread). Estimated pre-tax cost after accounting for underwriter spread and other flotation costs (the total of 1.5%). We calculate this adjusted pre-tax cost of debt as: original pre-tax estimate/(1-flotation cost %)

1) What is the adjusted pre-tax cost of debt (rd)? [show your work below]

WEIGHTED AVERAGE COST OF CAPITAL

1) What is the Weighted average cost of capital? Be sure to show your inputs in your WACC above and be sure to adjust for taxes as appropriate.

2) Discuss: Is this weighted average cost of capital a “good” hurdle rate to use for all new Walmart projects?

Answer 1

1) Pre tax cost of debt = Original pre tax estimate /(1-flotation cost)

Pre tax cost of debt	3.85%/(1-1.5%)
Pre tax cost of debt	3.91%
Beta	0.62
Rf	2%										Income Before Tax
Rm-Rf	5.50%										Income Tax Expense
So cost of equity	Rf + beta*(Rm-Rf)
Cost of equity	5.41%
Walmart
	2019	2018	Average
Long Term Debt	43,948,000	30,231,000	37,089,500	33%
Equity	72,496,000	77,869,000	75,182,500	67%
Total	116,444,000	108,100,000	112,272,000
Tax rate	34%
WACC	Cost	Post tax cost	%
Debt	3.91%	2.58%	33%
Equity	5.41%	5.41%	67%
WACC	4.47%
WACC is the ideal rate to consider for Walmart as any project with returns above WACC adds to firm value and projects with returns below WACC
erodes firm value