Wal-Mart cost of capital

Slide 1: The WACC is the weighted-average cost of capital. The capital structure of a firm consists of two main components debt and equity. Wal-Mart does not have preferred shares, so they can be excluded from this calculation. The cost of equity and cost of debt are different, so the weighted average cost of capital is the weighted average of the cost of equity and the cost of debt, as illustrated in the following formula:

Slide 2: Equity versus Debt

The choice between equity and debt reflects the trade-off between a number of different factors, including risk, control and access to capital. The risk characteristics of equity and debt are different, which is the main reason that they have different costs to the company. Equity payouts are subordinated to debt payouts, because debt payouts are done on a pre-tax basis and equity pay-outs are done on an after-tax basis. Thus, debtholders have lower risk, and demand a lower return. Equity shareholders, having higher risk, demand a higher return. For almost any company, the cost of debt will thus be lower than the cost of equity.

Slide 3: Cost of Debt

There are several components to the cost of debt. One cannot look at the face value interest rate, because that does not reflect today's market conditions. If the company has recently issued debt, that would be the easiest way to estimate the cost of debt. If there has not been a recent debt issue, then further research will need to be conducted.

Thus, the cost of debt can be found looking at the prevailing yield on the company's bonds, if they have any. This is the rate that the company would have to pay if it issued that debt today. The cost of debt will typically be estimated, because either the company does not have any bonds, or it has many, at different time periods. The best practice for determining which yield makes the most sense to build into the cost of debt should reflect the time period remaining on the company's current outstanding bonds.

Slide 4: Wal-Mart Cost of Debt

Just a couple of months ago, Wal-Mart issued debt privately. The debt was 30-year term, at 75 basis points above Treasuries (Smith & Boyle, 2017). There is no reason to...…company's stock price is.

Slide 11: Wal-Mart's Capital Structure

Circling back to the weighted average cost of capital, we need to determine the capital structure for Wal-Mart. This can be done by looking at the company's balance sheet. The total value of the company is $198,825 billion. Of this, the total value of shareholders' equity is $80,535 billion. This means that equity comprises 40.5% of the capital structure for Wal-Mart. There are no preferred shares, so the remainder is debt, which is 59.5% of the capital structure.

Slide 12: Weighted Average Cost of Capital

To calculate the WACC, you take the weights for debt and equity and applies the costs of each:

(.405)*(3.34) + (.595)*(3.63) = 1.354 + 2.159 = 3.513 %

Slide 13: Conclusions

Wal-Mart has an unusually low cost of capital. This is because the company has an unusually low cost of equity. With a very low beta, Wal-Mart equity is incredibly stable for investors, with risk nearly one-third of the market as a whole. This stability means that whether debt or equity, Wal-Mart's returns are very reliable. Indeed, recent upticks in the Treasury rates, even just since the company's most recent debt issue, have…