Question: We projected financial statements for Walmart
We projected financial statements for Walmart Stores for Years þ1 through +5. The data in Chapter 12 Exhibits 12.17–12.19 include the actual amounts for 2012 and the projected amounts for Year +1 to Year +5 for the income statements, balance sheets, and statements of cash flows for Walmart (in millions).
The market equity beta for Walmart at the end of 2012 was 1.00. Assume that the risk-free interest rate was 3.0% and the market risk premium was 6.0%. Walmart had 3,314 million shares outstanding at the end of 2012, and the share price was $69.09.
REQUIRED
Part I—Computing Walmart’s Value-to-Book Ratio Using the Value-to-Book Valuation Approach
a. Use the CAPM to compute the required rate of return on common equity capital for
Walmart.
b. Using the projected financial statements in Chapter 12 Exhibits 12.17–12.19, derive the projected residual ROCE (return on common shareholders’ equity) for Walmart for Years +1 through +5.
c. Assume that the steady-state, long-run growth rate will be 3% in Year +6 and beyond. Project that the Year +5 income statement and balance sheet amounts will grow by 3% in Year +6; then derive the projected residual ROCE for Year þ6 for Walmart.
d. Using the required rate of return on common equity from Requirement a as a discount rate, compute the sum of the present value of residual ROCE for Walmart for Years þ1 through +5.
e. Using the required rate of return on common equity from Requirement a as a discount rate and the long-run growth rate from Requirement c, compute the continuing value of Walmart as of the start of Year +6 based on Walmart’s continuing residual ROCE in Year +6 and beyond. After computing continuing value as of the start of Year +6, discount it to present value at the start of Year +1.
f. Compute Walmart’s value-to-book ratio as of the end of 2012 with the following three steps:
(1) Compute the total sum of the present value of all future residual ROCE (from Requirements d and e).
(2) To the total from Requirement f (1), add 1 (representing the book value of equity as of the beginning of the valuation as of the end of 2012).
(3) Adjust the total sum from Requirement f (2) using the midyear discounting adjustment factor.
g. Compute Walmart’s market-to-book ratio as of the end of 2012. Compare the value-to-book ratio to the market-to-book ratio. What investment decision does the comparison suggest? What does the comparison suggest regarding the pricing of Walmart shares in the market: underpriced, overpriced, or fairly priced?
h. Use the value-to-book ratio to project Walmart’s share value.
i. If you computed Walmart’s common equity share value using the dividends valuation approach in Problem 11.14 in Chapter 11, and/or the free cash flows to common equity valuation approach in Problem 12.17 in Chapter 12, and/or the residual income valuation approach in Problem 13.20 in Chapter 13, compare the value estimate you obtained in those problems with the estimate you obtained in this case. You should obtain the same value estimates under all four approaches. If you have not yet worked those problems, you would benefit from doing so now.
Part II—Analyzing Walmart’s Share Price Using the Value-Earnings Ratio, Price-Earnings Ratio, Price Differentials, and Reverse Engineering
j. Use the forecast data for Year +1 to project Year +1 earnings per share. To do so, divide Walmart’s projected comprehensive income available for common shareholders in Year +1 by the number of common shares outstanding at the end of 2012. Using this Year +1 earnings-per-share forecast and the share value computed in Requirement h, compute Walmart’s value-earnings ratio.
k. Using the Year +1 earnings-per-share forecast from Requirement j and using the share price of $69.09 at the end of 2012, compute Walmart’s price-earnings ratio. Compare Walmart’s value-earnings ratio with its price-earnings ratio. What does the comparison suggest regarding the pricing of Walmart shares in the market: underpriced, overpriced, or fairly priced? What investment decision does the comparison suggest? Does this comparison lead to the same conclusions you reached when comparing value-to-book ratios with market-to-book ratios in Requirement g?
l. Note: For this part only, assume Walmart’s long-run growth beginning in Year +6 will be 1% rather than 3%. With a 1% growth rate, Year +6 comprehensive income will be $21,059 million. Compute Walmart’s price differential at the end of 2012. Compute Walmart’s price differential as a percentage of Walmart’s risk-neutral value. What dollar amount and what percentage amount has the market discounted Walmart shares for risk?
m. Reverse engineer Walmart’s share price at the end of 2012 to solve for the implied expected rate of return. First, assume that value equals price and that the earnings and 3% long-run growth forecasts in Year þ6 and beyond are reliable proxies for the market’s expectations for Walmart. Then solve for the implied expected rate of return (the discount rate) the market has impounded in Walmart’s share price.
(Hint: Begin with the forecast and valuation spreadsheet you developed to value Walmart shares.
Vary the discount rate until you solve for the discount rate that makes your value estimate exactly equal the end-of-2012 market price of $69.09 per share.)
n. Reverse engineer Walmart’s share price at the end of 2012 to solve for the implied expected long-run growth. First, assume that value equals price and that the earnings forecasts through Year +5 are reliable proxies for the market’s expectations for Walmart. Also assume that the discount rate implied by the CAPM (computed in Requirement a) is a reliable proxy for the market’s expected rate of return. Then solve for the implied expected long-run growth rate the market has impounded in Walmart’s share price.
(Hint: Begin with the forecast and valuation spreadsheet you developed to value Walmart shares and use the CAPM discount rate. Set the long-run growth parameter initially to zero. Increase the long-run growth rate until you solve for the growth rate that makes your value estimate exactly equal the end-of-2012 market price of $69.09 per share.)
Transcribed Image Text:
Exhibit 12.17 Walmart Stores, Inc. Income Statements for 2012 (Actual) and Year +1 through Year +5 (Projected) (amounts in millions; allow for rounding) (Problem 12.17) Actual Projected 2012 Year +1 Year +2 Year +3 Year +4 Year +5 $ 469,162 $ 487,928 $ 527,743 $ 570,807 $ 507,446 (380,584) $ 126,861 Revenues $ 548,853 Cost of goods sold (352,488) (365,946) (395,808) $ 131,936 (411,640) (428,105) $ 137,213 $ 142,702 Gross Profit $ 116,674 $ 121,982 Selling, general, and administrative expenses (88,873) (92,706) (96,415) (100,271) (104,282) (108,453) Interest income 187 202 202 202 202 202 Interest expense (2,522) $ 30,612 (2,251) (2,308) $ 27,170 (2,377) $ 28,272 (9,047) (2,448) (2,597) $ 31,853 (10,193) Income before tax $ 25,737 $ 29,419 Income tax expense (7,981) (8,694) (9,414) (9,796) Income attributable to noncontrolling interests (757) (809) (809) (809) (809) (809) Net Income Attributable to Common Shareholders $ 16,999 $ 17,666 $ 18,416 $ 19,195 $ 20,007 $ 20,851 Source for Actual 2012: Walmart Stores, Inc, Form 10K for the Fiscal Year Ended January 31, 2013. Exhibit 12.18 Walmart Stores, Inc. Balance Sheets for 2012 (Actual) and Year +1 through Year +5 (Projected) (amounts in millions; allow for rounding) (Problem 12.17) Actual Projected 2012 Year +1 Year +2 Year +3 Year +4 Year +5 ASSETS $ 7,781 $ 7,781 $ 7,781 $ 7,781 $ 7,781 $ 7,781 7462 Cash and cash equivalents Accounts receivable-net 6,768 7,106 7,835 8,227 8,638 Inventories 43,803 44,114 45,879 47,714 49,622 51,607 Prepaid expenses and other current assets 1,588 1,652 1,718 1,786 1,858 1,932 current assets $ 59,940 $ 60,653 $ 62,839 $ 65,116 $ 67,488 $ 69,958 Property, plant & equipment- at cost 171,724 184,224 196,724 209,224 221,724 234,224 (84,552) Accumulated depreciation Goodwill and other assets (55,043) (64,254) (74,090) (95,638) (107,349) 28,645 $203,105 $208,166 $214,118 $219,579 $24,556 $ 229,055 26,484 27,543 29,791 30,983 32,222 Total Assets LIABILITIES Accounts payable-trade Current accrued expenses $ 38,080 $ 38,131 $ 39,806 $ 41,398 21,156 $ 43,054 $ 44,777 18,808 19,560 20,343 22,003 22,883 7,219 Notes payable and short-term debt Current maturities of long-term 6,805 7,009 7436 7,659 7,889 debt 5,914 6,091 6,274 6,462 6,656 6,856 2,488 2,563 $ 81,861 $ 84,967 Income taxes payable 2,211 $ 71,818 2,277 $ 73,069 2,346 $ 75,988 43,939 2416 $ 78,869 Current Liabilities Long-term debt 41,417 42,660 45,257 46,615 48,014 Deferred tax liabilities-noncurrent 7,613 7,841 8,077 8,319 8,568 8,826 Redeemable noncontrolling interest 519 Total Liabilities $121,367 $123,570 $1 28,004 $132,446 $137,045 $ 141,807 SHAREHOLDERS' EQUITY Common stock + paid-in capital Retained earnings 3,952 4,163 4,282 4,392 4,491 4,581 72,978 75,625 77,023 77,934 78,213 77,859 Accum. other comprehensive income (loss) (587) $ 76,343 (587 $ 79,201 (587) $ 80,719 5,395 (587) (587) (587) Common Shareholders' EQUITY $ 81,738 $ 82,117 $ 81,853 Noncontrolling interests Total EQUITY 5,395 5,395 5,395 5,395 5,395 87,248 81,738 $203,105 84,596 86,114 $214,118 87,133 $219,579 87,512 Total Liabilities and Equities $208,166 $224,556 $ 229,055 Source for Actual 2012 Walmart Stes, Inc., Form 10K for the Fiscal Year Ended January 31, 2013. Exhibit 12.19 Walmart Stores, Inc. Projected Implied Statements of Cash Rows for Year +1 through Year +5 (Problem 12.17) Projected Year +1 Year +2 Year +3 Year +4 Year +5 IMPLIED STATEMENTS OF CASH FLOWS $ 18,476 $ 20,005 10,461 Net income $ 19,225 $ 20,816 $ 21,660 Add back depreciation expense (net) (Increase) Decrease in receivables-net (Increase) Decrease in inventories (Increase) Decrease in prepaid expenses 9,211 9,836 11,086 11,711 (338) 355) (373) (392) (411) (1,985) (311) (1,765) (1,835) (69) (1,909) (64) (66) (71) (74) Increase (Decrease) in accounts payable-trade 51 1,675 1,592 1,656 1,722 Increase (Decrease) in current acaued liabilities 752 782 814 846 880 Increase (Decrease) in income taxes payable 66 68 70 72 75 Net change in deferred tax assets and liabilities 228 235 242 250 257 Net Cash Flows from Operations $ 28,072 $ 29,636 $ 30,908 $ 32,355 $ 33,835 (Increase) Decrease in prop, plant, & equip, at cost (Increase) Decrease in goodwill and nonamort. intang. (12,500) (12,500) (12,500) (12,500) (12,500) (820) (853) (887) (922) (959) (Increase) Decrease in other noncurrent assets (239) $(13,559) 249) $(13,602) (259) $(13,646) (269) $(13,692) (280) $(13,739) Net Cash Flows from Investing Activities Increase (Decrease) in short-term debt 382 393 405 417 429 Increase (Decrease) in long-term debt Increase (Decrease) in redeemable noncontrolling interest Increase (Decrease) in common stock + paid-in capital 1,243 1,280 1,318 1,358 1,398 (519) 211 119 109 100 90 Increase (Decrease) in accumulated OCI Dividends (15,020) (17,017) (18,285) (19,728) (21,204) Increase (Decrease) in noncontrolling interests Net Cash Flows from Financing Activities (809) B09) $(16,035) (809) (809) $(18,663) (809) $(14,513) $(17,262) $(20,096) Net Change in Cash
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> Obtain Apple Inc.’s 2016 annual report either through the ‘‘Investor Relations’’ portion of their website (do a web search for Apple investor relations) or go to www.sec.gov and click ‘‘Company Filings Search’’ under ‘‘Filings.’’ Required: Answer the fo
> Lola, the CEO of JB Inc., and Frank, the accountant for JB Inc., were recently having a meeting to discuss the upcoming release of the company’s financial statements. Following is an excerpt of their conversation: Lola: These financial statements don’t s
> Professional ethics guide public accountants in their work with financial statements. Required: Why is ethical behavior by public accountants important to society? Be sure to describe the incentives that public accountants have to behave ethically and u
> Reproduced below are portions of the president’s letter to stockholders and selected income statement and balance sheet data for the Wright Brothers Aviation Company. Wright Brothers is a national airline that provides both passenger se
> Define the terms revenue and expense. How are these terms related?
> Agency Rent-A-Car Inc. rents cars to customers whose vehicles are unavailable due to accident, theft, or repair (‘‘Wheels while your car heals’’). The company has a fleet of more tha
> Which of the following statements regarding business activities is true? a. Operating activities involve buying the long-term assets that enable a company to generate revenue. b. Financing activities include obtaining the funds necessary to begin and ope
> The accounting profession is organized into three major groups: (a) Accountants who work in nonbusiness entities, (b) Accountants who work in business entities, and (c) Accountants in public practice. The periodical literature of accounting includes
> Jim Hadden is a freshman at Major State University. His earnings from a summer job, combined with a small scholarship and a fixed amount per term from his parents, are his only sources of income. He has a new MasterCard that was issued to him the week he
> Which of the following statements is false concerning forms of business organization? a. A corporation has tax advantages over the other forms of business organization. b. It is easier for a corporation to raise large sums of money than it is for a sole
