The market equity beta for Walmart at the end of 2015 is 1.00. Assume that the risk-free interest rate is 3.0% and the market risk premium is 6.0%. Walmart has 3,162 million shares outstanding at the end of 2015, and the share price
was $67.50.
Part I-Computing Walmart's Share Value Using Free Cash Flows to Common Equity Shareholders
a.
Following the CAPM, Walmart faces a required rate of return on equity capital of
9.0% at the end of Year 4. This rate is computed as follows:
E[RWMT] = E[RF] + βWMT × E[RM - RF]
= 3.0% + (1.0 × 6.0%)
= 9.0%
b.
Exhibit 12.D presents the excerpts from FSAP for the valuation of Walmart based on projected free cash flows to common equity. The first rows of the table present the computations for Walmart's projected free cash flows for common equity shareholders for Years +1 through +5. The right-most column contains the projected free cash flows for common equity shareholders in Year +6 based on the projected Year +6 financial statements, assuming 3.0% long-run growth. The remaining rows of the table include discounting the free cash flows for Years +1 through +5 to present value, computing continuing value, and computing share value. The share value estimate is $86.88, which is identical to the estimate using the dividends model
Projected free cash flows for common equity shareholders in Years +1 to +5 are as follows:
Net Cash Flows from Operations
+(–) Decr. (Incr.) in Cash Required for Operations
Net Cash Flow from Investing
Net Cash Flows from Debt Financing Net Cash Flows for Non controlling Interests
Free Cash Flows for Common Equity
Year +1 | Year +2 | Year +3 | Year +4 | Year +5 | ||||||
$ 24,405.8 | $ 26,032.3 | $ 26,837.2 | $ 27,635.8 | $ 28,439.8 | ||||||
0.0 | 0.0 | 0.0 | 0.0 | 0.0 | ||||||
(10,456.5) | (10,465.7) | (10,475.0) | (10,484.5) | (10,494.2) | ||||||
1,501.0 | 1,546.1 | 1,592.4 | 1,640.2 | 1,689.4 | ||||||
(386.2) | (386.2) | (386.2) | (386.2) | (386.2) | ||||||
$ 15,064.1 | $ 16,726.5 | $ 17,568.5 | $ 18,405.3 | $ 19,248.9 |
c.
Projected free cash flows for common equity shareholders in Year +6 are as follows:
Year +6 | ||
Net Cash Flows from Operations | $20,961.3 | |
+(–) Decrease (Increase) in Cash Required for Operations | (261.2) | |
Net Cash Flow from Investing | (7,897.7) | |
Net Cash Flows from Debt Financing | 1,740.1 | |
Net Cash Flows for Non controlling Interests | (305.8) | |
Free Cash Flows for Common Equity | $14,236.8 |
d.
The data in Exhibit 12.D show that the sum of the present value of free cash flows for common equity for Walmart for Years +1 through +5, discounted at 9.0%, is $67,013.9 million.
e.
The data in Exhibit 12.D show that the present value at the start of Year +1 of the continuing free cash flows for common equity in Years +6 and beyond amounts to $154,215.2 million [= $14,236.8/(0.090 – 0.03) × 0.650]. (Allow for rounding. The actual present value factor used in Excel is 0.649931.)
f.
The data in Exhibit 12.D show the following computations:
(1)
The sum of the present value of free cash flows for common equity is $221,229.2 million = ($67,013.9 million + $154,215.2 million).
(2)
After adjusting the sum of the present value using the midyear discounting adjustment factor of 1.0450 = (1 + .090/2), the total present value of free cash flows for common equity is $231,184.5 million.
(3)
The per-share value estimate for Wal-Mart, after dividing the total present value by the 3,162 million shares outstanding, equals $73.11.
Exhibit 12.D
Free-Cash-Flows-Based Valuation of Walmart Stores
(amounts in millions except per share amounts)
Part II—Computing Walmart’s Share Value Using Free Cash Flows to All Debt and Equity Stakeholders
g.
Walmart’s capital structure at the end of 2015 consists of the following amounts and proportions:
The equation presented in Chapter 12 for computing weighted average cost of capital is as follows:
R_{A} = [w_{D} × R_{D} × (1 – tax rate)] + [w_{P} × R_{P}] + [w_{E} × R_{E}] + [w_{NCI} × R_{NCI}]
Using this equation, Walmart’s weighted average cost of capital at the end of 2015 is computed as follows:
R_{A} = [0.178 × 0.050 × (1 – 0.320)] + [0.811 × 0.090] + [0.011 × 0.1259]
= 0.604 + 7.297 + 0.147
= 8.047%
Exhibit 12.E presents the excerpts from FSAP for the valuation of Walmart based on projected free cash flows to all debt and equity stakeholders. The first rows of the table present the computations for Walmart’s projected free cash flows for all debt and equity stakeholders for Years +1 through +5. The right-most column contains the projected free cash flows for all debt and equity stakeholders in Year +6 based on the projected Year +6 financial statements, assuming 3.0% long-run growth. The remaining rows of the table include discounting the free cash flows for Years +1 through +5 to present value discounted using the weighted-average cost of capital from Part g, computing continuing value, and computing share value. The share value estimate is $72.58, which differs slightly from the value estimate of $73.11 in Part f above.
In computing weighted-average cost of capital in Part g, we determined the weight of equity using the market price of Walmart’s stock at the time. Our share value estimates from Parts f and l differ from the market price, so the weights we used to compute the weighted -average cost of capital are not internally consistent with the share values we have estimated. In addition, we hold the weighted-average cost of capital constant over time, even though our forecasts project that the debt-equity weights will change.
h.
Projected amounts of free cash flows for all debt and equity stakeholders in Years +1 through +5 are as follows:
i.
Projected free cash flows for all debt and equity stakeholders in Year +6 are as follows:
Net Cash Flow from Operations | Year +6 | ||
$20,961.3 | |||
Add Back: Interest Expense after Tax | 2,001.7 | ||
Subtract: Interest Income after Tax | 0.0 | ||
+(–) Decr. (Incr.) in Cash Required for Operations | (261.2) | ||
Free Cash Flow from Operations | $22,701.8 | ||
Net Cash Flow from Investing | (7,897.7) | ||
Add Back: Cash Flows into Financial Assets | 0.0 | ||
Free Cash Flow—All Debt and Equity | $14,804.2 | ||
j.
The data in Exhibit 12.E show that the sum of the present value of free cash flows for all debt and equity stakeholders for Walmart for Years +1 through +5, discounted at a weighted-average cost of capital of 8.047%, is $71,265.2 million. You could query students about whether the free-cash-flows model correctly measures the value being added by Walmart’s operations during this period. The answer, of course, is no because the model places emphasis on the cash outflows for growth in assets and does not yet include all of the cash flows that Walmart will realize from this growth, which will occur in future years.
k.
The data in Exhibit 12.E show that the present value at the start of Year +1 of the continuing free cash flows for all debt and equity stakeholders in Years +6 and beyond amounts to $199,171.7 million = [($14,804.2 million/(0.08047 – 0.03)) × 0.679]. (Allow for rounding.)
l.
The data in Exhibit 12.E show the following computations:
(1)
The sum of the present value of free cash flows for all debt and equity stakeholders is $270,436.9 million = ($71,265.2 million + $199,171.7 million).
(2)
Subtracting the value of debt and noncontrolling interests provides the present value of common equity, which is $220,633.9 million = ($270,436.9 million – $46,738.0 million – $3,065.0 million).
(3)
After adjusting the sum of the present value using the midyear discounting adjustment factor of 1.0402 = (1 + 0.08047/2), the total present value of free cash flows for all debt and equity stakeholders is $229,511.7 million.
(4)
The per-share value estimate for Walmart, after dividing the total present value by the 3,162 million shares outstanding, equals $72.58.
Exhibit 12.E
Free-Cash-Flows-Based Valuation of Walmart Stores
(amounts in millions except per share amounts)
Part III—Sensitivity Analysis and Recommendation
m.
The data in Exhibit 12.F show the results of various sensitivity analysis scenarios, varying discount rates and growth rates.
Scenario 1:
If we assume that Walmart’s long-run growth will be 2%, not 3% as above, and that Walmart’s required rate of return on equity is one percentage point higher than the rate computed using the CAPM in Part a (that is, 10.0%), the resulting share value estimate falls to $59.75 per share. That amount is 18% lower than our base case estimate of $73.11, and 11% lower than the current market price of $67.50.
Scenario 2:
If we assume that Walmart’s long-run growth will be 4%, not 3% as above, and that Walmart’s required rate of return on equity is one percentage point lower than the rate computed using the CAPM in Part a (that is, 8.0%), the resulting share value estimate increases to $99.30 per share. That amount is 36% greater than our base case estimate of $73.11 and 47% greater than the current share price of $67.50.
n.
At the start of Year +1, Walmart’s share price was $67.50. Our baseline share value estimate is $73.11, implying that Walmart shares are under priced by roughly 8%. Sensitivity analysis reveals that slight variations in the long-term growth rate and discount rate can cause the share value estimate to vary between $59 per share (11% below the current price) up to $99 per share (47% above the current price). If our forecast and valuation assumptions are reasonable, the current share price falls in the bottom half of this value estimate range. We would have concluded that Walmart shares are slightly under priced at roughly $67.50; therefore, we would have recommended a buy.
Exhibit 12.F
Free-Cash-Flows-Based Valuation of Walmart Stores—Sensitivity Analyses