Valuing Wal-Mart -2010 Harvard Case Solution & Analysis

Introduction

Wal-Mart is the largest retailer store and is operating internationally with more than 8400 stores all over the world. Wal-Mart is famous for proving daily household and about every product of daily routine life at every low price, that’s why the financial statements for the last two years showing great profits.

Problem Identification

Gupta is an investment advisor who provides help to its clients regarding investment. She works in a brokerage house present in India. She is considering the stocks of Wal-Mart in order to help its clients whether to invest in Wal-Mart or not and also suggests its client who already has Wal-Mart shares in their portfolio that sell or hold the equity.

The perpetual, constant growth model

The perpetual, constant growth model identifies the value of the stocks of the company by assuming that it will be equal to the amount of the discounted value of dividend paid by the company and it is also expected that the dividend amount will grow with the constant ratio and this growth will continues throughout the life of the company.

In case of the Wal-Mart it is expected that it will pay 1.21 dollars as a dividend in the next year and according to the estimates of an analyst it is expected that the dividend amount will represent a constant growth of five percent in perpetuity.

In order to determine the present value of the dividend paid in perpetuity a suitable WACC should be calculated. The dividend discount model measures the value of stocks of the company so the cost of equity will be equal to cost of capital of the overall company in order to determine the present values of the dividend paid by the company.

Cost of equity is calculated with the help of capital asset pricing model for the purpose of the calculation of the discounted dividend amount in order to estimate the value of stocks of the Wal-Mart. According to the estimates of an analyst the Beta of Wal-Mart is 0.66 and current government bond rate is taken as a risk free rate for the purpose of calculating cost of equity for Wal-Mart.

According to the historical analysis, it is predicted that the market risk premium for the US market will be 5.05 percent. Therefore, by computing the values of risk free debt, Wal-Mart’s beta and the market risk premium into the formula of capital asset pricing model cost of equity is determined which is 7.01 percent.

This cost of equity is used as a cost of capital in order to discount the values of the dividend paid by the company. By calculating the discounted value of the dividend in perpetuity, it is noted that the value of the stock of Wal-Mart will be 60.10 and the current market price of the Wal-Mart is 53.48. So the value calculated by the discounted dividend model is reasonably higher than the current price, therefore investing in Wal-Mart and holding the existing shares is beneficial for the both new and existing shareholders

Forecasted dividends for the next several years 

The dividend through discounted dividend model could be calculated for several years. It could be calculated for 50 or 100 years. But it will be inappropriate and unrealistic because the cost of capital and the growth rate could not be same for such a large period.

It is expected that the cost of equity will remain same for the next 10 years and the dividend amount will grow with the same percentage in the next ten years. Therefore, by taking the ten years cost of equity as a cost of capital and adding five percent growth in the value of the dividend for next ten year value of the stock is calculated.

Excel is showing the figures for the calculation of dividend for the next 10 years by accumulated the constant growth of five percent and the value of the stock of the company is also calculated by discounting the value of dividend with the 7.01 percent cost of capital. This value of stock is also discounted by using the same value of the cost of capital.

Adding the discounted value of dividends and discounted value of the stock for the tenth year gives the total value of the stock of Wal-Mart. The tenth year’s figure of the stock also shows the potential of gains on buying or holding the Wal-Mart’s stock for the next few years...............

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