Wal-Mart Capital Structure and Financial Analysis - Case Study Example

EXECUTIVE SUMMARY Calculation of Wal-Mart's total equity, which is done by using the data obtained from the company's financial ments. Calculation of Wal-Mart's total debt, which is done by using the data obtained from the company's financial statements. Calculation of Wal-Mart's asset flow, which is done by using the data obtained from the company's financial statements Financial ratio analysis, demonstrating the use of two key ratios to determine the company's debt-to-equity relationship and the capital structure. Weighted Average Cost of Capital (WACC) calculation with proper steps. Explanation of items used in the calculation The analysis and explanation of Wal-Mart's capital structure as based on the ratio calculations. Discussion on appropriateness of Wal-Mart's capital structure in the context of retail industry. CALCULATION OF WAL-MART'S EQUITY, DEBT AND ASSET FLOW Based on the data obtained from the financial statements of Wal-Mart for the financial year 2005, the company's Equity, debt and asset flow are calculated below: Wal-Mart-- Equity A firm's equity can be calculated by subtracting total liabilities from total assets or adding liabilities to the shareholder's funds. The Wal-Mart company's total equity is calculated as follows: Total Assets $120,223 Less: Total Liabilities (70,827) Total Equity $49,396 Wal-Mart-- Total Debt Total debt of a firm comprises all the long-term, short-term and medium-term debts of a company that has been borrowed from external sources. The total debt of Wal-Mart has been calculated below: Total Short-term Debt $3969 Total Long-term Debt 23,669 Total Debt $27,638 Wal-Mart-Asset Flow Asset Flow = Sales_____ Total Asset = $285,222 = 2.37 $120,223 RATIO ANALYSIS: The use of key financial ratios as relevant to the evaluation of capital structure would be helpful in analysing the company's debt to equity relationship: Debt Ratio The debt ratio is used to show the total proportion of a firm's assets being financed by external borrowings. It analyses a company's financial risk in terms of longer term funding arrangements. The debt ratio for Wal-Mart has been calculated below: Debt Ratio = Total Debt Finance_________ x 100 Total Assets (Fixed + Current) = $27,638_ x 100 $120,223 = 22.9% Debt to Equity Ratio The debt to equity ratio measures the relationship between a company's debt capital and equity capital. It shows the percentage of a company's equity that has been financed by external debts. The debt-to-equity ratio for Wal-Mart has been calculated as: Debt-to-Equity Ratio = Total Debt Capital x 100 Total Equity Capital = $27,638 x 100 $49,396 = 55.95% CALCULATION OF WEIGHTED AVERAGE COST OF CAPITAL In the Weighted Average Cost of Capital (WACC) involves the calculation of separate items in the capital employed and then weighting the cost of each element by its proportion of the total capital employed. There are following factors in the Wal-Mart's total capital: Equity (Common Stock) Debt (Long-term Debts) $ % Of Total 4,311 Common Stock of $0.10 (par) 423m 1.75% Long-term Debt 23,669m 98.24% Total Capital Employed 24,092m 100% Cost of Equity The cost of equity estimates the cost of common and preferred stock. But for Wal-Mart, this calculation will not include preference stock because the company has not issued any preference shares. The analysis of Wal-Mart's annual report reveals that the company is expecting to pay $0.150 dividend per share to its common shareholders. For dividend growth, we assume it to be 10% annually. The cost of common share capital has been estimated with the help of following formula: Cost of Common Share Capital = (Next annual dividend / current market price) + annual dividend growth = ($0.150 per share / $50.49 per share) + 10% = 10.29% per annum. Cost of Debt The calculation of cost of debt will encompass all the interest bearing long-term debts of the company. According to the Wal-Mart's annual report, the company's weighted average effective interest rate on long-term debt is 4.08% in 2005. The tax rate applicable to the company for the year is 34.7%. The cost of long-term debt has been estimated as: Cost of long-term debt = YTM (1-t) = 4.08% (1- 34.57%) = 0.0408 x 0.6543 = 2.67% Now, after calculating the separate cost elements, the Weighted Average Cost of Capital (WACC) for Wal-Mart can be calculated as: WACC = WdKd + WpKp i.e., (Cost of common stock x proportion of capital employed) + (cost of long-term debt x proportion of capital employed) = (10.29%)0.0175 + (2.67%)0.9824 = (0.1029)(0.0175) + (0.0267)(0.9824) = 0.00180075 + 0.02623008 = 2.8% Therefore, it shows that the Weighted Average Cost of Capital for Wal-Mart Inc. is 2.8% per annum. ANALYSIS OF WAL-MART'S CAPITAL STRUCTURE IN THE CONTEXT OF RETAIL INDUSTRY: As analysed from the company's financial statements and the calculation of financial ratios, the capital structure of Wal-Mart has become evident. Wal-Mart has structured its capital funding in a way its external debts or borrowings do not exceed its total equity to a greater extent. It means that the company does not over depend on the external funds and borrowings to finance its assets or to keep the business going. The relationship between debt and equity finance is used to define the level of financial gearing or leverage in a company. In terms of returns, a company will normally be obliged to pay a contractually fixed rate of return to the providers of its debt or borrowed capital. In this case, Wal-Mart has to pay more dividends (to its shareholders) than the interest (to its lenders). The return to equity shareholders will be in the form of dividend payments, which are, in contrast, discretionary payments determined by the company's directors. Companies are not obliged to pay their shareholders a dividend. The objective of the capital structure assessment is to obtain an indication of Wal-Mart's longer-term solvency and its degree of financial risk, thus the main focus here is on the firm's long-term funding arrangements. Financial risk is the risk of the firm not being able to pay its financial commitments for which the ultimate penalty is liquidation. This examination is of very much interest to lenders and shareholders, to help them assess their risk of advancing capital to the firm. The Wal-Mart's capita structure does not depend much on borrowed funds. It shows that Wal-Mart does not suffer from this longer-term financial risk or in other words, it can be said that Wal-Mart is able to pay off its long-term liabilities and obligations whenever a need may arise. Wal-Mart is an international retail giant and the industry leader. It occupies the greatest market capitalization in the retail industry. According to reuters.com (Retail (Department & Discount) Industry, accessed 26.11.2005), the retail industry average for debt-to-equity ratio is about 71% whereas Wal-Mart's debt-to-equity ratio as calculated above shows 55.95%. It means that most of the companies in the retail industry have the external borrowings and debts of more-or-less 71% of their total equity. This shows that although these companies do not over rely on borrowed funds in their capital structure but they rely on it more than the Wal-Mart does. This has many other aspects, including the payment of interest and dividends, as interest is obligatory and dividend is not. Less-reliance on borrowed funds is also attractive for the investors willing to invest in the company, as it gives an impression that the company has sufficient funds to carry out its business without overly relying on the funds obtained from external sources. Therefore, it can be said that Wal-Mart has an appropriate capital structure. Works Cited: Annual Report 2005, November 26, 2005: http://library.corporate-ir.net/library/11/112/112761/items/146737/WAL-MART_final.pdf Retail (Department & Discount) Industry, November 26, 2005: http://www.investor.reuters.com/IndustryCenter.aspxindustry=RTDEPT&target=industrycenter Read More