\u201cEstimating Walmart’s Cost of Capital\u201d Case Study<\/p>\n\n\n\n
4. How should Dale and Lee estimate the cost of long-term debt? Should short-term debt be considered in calculating the cost of capital?<\/p>\n\n\n\n
5. How should Dale and Lee estimate the cost of equity?<\/p>\n\n\n\n
a. Use the dividend discount model to estimate the cost of equity. Calculate growth rate using historical dividend growth rate and ROE*retention ratio formula (This means you will have two estimates for cost of equity using dividend discount model. One will use the growth rate that you estimate using historical numbers. The other one will use the growth rate you estimate using the ROE*retention ratio formula)<\/p>\n\n\n\n
b. Use the capital asset pricing model to estimate the cost of equity.<\/p>\n\n\n\n
c. Discuss which model is more appropriate in this case<\/p>\n\n\n\n
The correct answer and explanation is :<\/strong><\/mark><\/p>\n\n\n\n Answer:<\/strong><\/p>\n\n\n\n 4. Estimating Cost of Long-Term Debt and Inclusion of Short-Term Debt<\/strong><\/p>\n\n\n\n Dale and Lee should estimate Walmart\u2019s cost of long-term debt by calculating the yield to maturity (YTM)<\/strong> on Walmart\u2019s existing long-term bonds. The YTM reflects the market\u2019s required return on the company\u2019s debt and captures current borrowing costs better than the coupon rate. If YTM data is unavailable, they can use the interest expense divided by the average total debt from Walmart\u2019s financial statements as a proxy, adjusted for tax:<\/p>\n\n\n\n After-Tax Cost of Debt = YTM \u00d7 (1 \u2013 Tax Rate)<\/strong><\/p>\n<\/blockquote>\n\n\n\n Should short-term debt be included?<\/strong> 5. Estimating Cost of Equity<\/strong><\/p>\n\n\n\n a. Dividend Discount Model (DDM):<\/strong> Cost of Equity (r) = (D\u2081 \/ P\u2080) + g<\/strong><\/p>\n<\/blockquote>\n\n\n\n Where:<\/p>\n\n\n\n Growth Rate Estimate 1: Historical Dividend Growth<\/strong> Growth Rate Estimate 2: ROE \u00d7 Retention Ratio<\/strong><\/p>\n\n\n\n g = ROE \u00d7 (1 \u2013 Dividend Payout Ratio)<\/strong><\/p>\n<\/blockquote>\n\n\n\n Use Walmart\u2019s ROE and dividend payout data to compute.<\/p>\n\n\n\n b. Capital Asset Pricing Model (CAPM):<\/strong><\/p>\n\n\n\n Cost of Equity = Risk-Free Rate + Beta \u00d7 Market Risk Premium<\/strong><\/p>\n<\/blockquote>\n\n\n\n Use the U.S. Treasury yield as the risk-free rate, Walmart\u2019s beta (from Bloomberg or Yahoo Finance), and a standard market risk premium (e.g., 5\u20136%).<\/p>\n\n\n\n c. Discussion \u2013 Which Model is More Appropriate?<\/strong><\/p>\n\n\n\n In Walmart\u2019s case, CAPM is more appropriate<\/strong>. DDM assumes that dividends grow at a constant rate, which can be unreliable for companies with changing payout policies or significant reinvestments like Walmart. CAPM incorporates market risk (via beta) and is widely used in practice for valuing large, publicly traded firms. It reflects systematic risk and does not rely on potentially unstable dividend growth estimates. Given Walmart\u2019s diversified operations and its beta reflecting overall market exposure, CAPM provides a more realistic and dynamic measure of equity cost.<\/p>\n\n\n\n Conclusion:<\/strong> \u201cEstimating Walmart’s Cost of Capital\u201d Case Study 4. How should Dale and Lee estimate the cost of long-term debt? Should short-term debt be considered in calculating the cost of capital? 5. How should Dale and Lee estimate the cost of equity? a. Use the dividend discount model to estimate the cost of equity. Calculate growth […]<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[],"tags":[],"class_list":["post-6231","post","type-post","status-publish","format-standard","hentry"],"_links":{"self":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/6231","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/comments?post=6231"}],"version-history":[{"count":1,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/6231\/revisions"}],"predecessor-version":[{"id":6232,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/posts\/6231\/revisions\/6232"}],"wp:attachment":[{"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/media?parent=6231"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/categories?post=6231"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/gaviki.com\/blog\/wp-json\/wp\/v2\/tags?post=6231"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}\n
Yes, short-term debt should be included<\/strong> in calculating the weighted average cost of capital (WACC)<\/strong> if it is a permanent part of Walmart\u2019s capital structure<\/strong> (not seasonal or operational). If Walmart regularly relies on short-term borrowing to finance operations or investments, excluding it would underestimate the firm\u2019s total cost of capital.<\/p>\n\n\n\n
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The formula:<\/p>\n\n\n\n\n
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Calculate the compound annual growth rate (CAGR) of dividends over the past several years.<\/p>\n\n\n\n\n
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Use YTM for long-term debt, include permanent short-term debt in WACC, and prefer CAPM for cost of equity. Use DDM for sensitivity analysis.<\/p>\n","protected":false},"excerpt":{"rendered":"