CALCULATE THE COST OF DEBT; Walmart has at least 50 long-term bonds, the weighted average yield on...

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CALCULATE THE COST OF DEBT;
Walmart has at least 50 long-term bonds, the weighted averageyield on these bonds is 3.2%. On the other hand, a simplified costof debt can be calculated as the interest expenses divided by twoyear average of book value of debt. For Walmart, the book andmarket value of debt is nearly identical. This estimated cost ofdebt is 4.49%.
For our purposes, we will take the average, and use 3.85% as thepre-tax cost of debt (preliminary).
Now that we have the average pre-tax cost of debt, we need toaccount for the underwriter spread. We are simplifying fromflotation costs calculated for equity. The adjusted pre-tax cost ofdebt should be estimated rate (from above)/(1-UW spread). Estimatedpre-tax cost after accounting for underwriter spread and otherflotation costs (the total of 1.5%). We calculate this adjustedpre-tax cost of debt as: original pre-tax estimate/(1-flotationcost %)
1) What is the adjusted pre-tax cost of debt (rd)? [showyour work below]
WEIGHTED AVERAGE COST OF CAPITAL
1) What is the Weighted average cost of capital? Be sureto show your inputs in your WACC above and be sure to adjust fortaxes as appropriate.
2) Discuss: Is this weighted average cost of capital a“good” hurdle rate to use for all new Walmartprojects?

Answer & Explanation Solved by verified expert

4.2 Ratings (738 Votes)

1) Pre tax cost of debt = Original pre tax estimate /(1-flotation cost)

Pre tax cost of debt	3.85%/(1-1.5%)

Pre tax cost of debt	3.91%

Beta	0.62
Rf	2%				Income Before Tax
Rm-Rf	5.50%				Income Tax Expense

So cost of equity	Rf + beta*(Rm-Rf)
Cost of equity	5.41%

Walmart
	2019	2018	Average
Long Term Debt	43,948,000	30,231,000	37,089,500	33%
Equity	72,496,000	77,869,000	75,182,500	67%
Total	116,444,000	108,100,000	112,272,000

Tax rate	34%

WACC	Cost	Post tax cost	%
Debt	3.91%	2.58%	33%
Equity	5.41%	5.41%	67%

WACC	4.47%

WACC is the ideal rate to consider for Walmart as any project with returns above WACC adds to firm value and projects with returns below WACC
erodes firm value

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CALCULATE THE COST OF DEBT;Walmart has at least 50 long-term bonds, the weighted averageyield on these bonds is 3.2%. On the other hand, a simplified costof debt can be calculated as the interest expenses divided by twoyear average of book value of debt. For Walmart, the book andmarket value of debt is nearly identical. This estimated cost ofdebt is 4.49%.For our purposes, we will take the average, and use 3.85% as thepre-tax cost of debt (preliminary).Now that we have the average pre-tax cost of debt, we need toaccount for the underwriter spread. We are simplifying fromflotation costs calculated for equity. The adjusted pre-tax cost ofdebt should be estimated rate (from above)/(1-UW spread). Estimatedpre-tax cost after accounting for underwriter spread and otherflotation costs (the total of 1.5%). We calculate this adjustedpre-tax cost of debt as: original pre-tax estimate/(1-flotationcost %)1) What is the adjusted pre-tax cost of debt (rd)? [showyour work below]WEIGHTED AVERAGE COST OF CAPITAL1) What is the Weighted average cost of capital? Be sureto show your inputs in your WACC above and be sure to adjust fortaxes as appropriate.2) Discuss: Is this weighted average cost of capital a“good” hurdle rate to use for all new Walmartprojects?