In Integrative Case 10.1, we projected financial statements for Walmart Stores for Years +1 through +5. The data in Chapter 12, Exhibits 12.17, 12.18, and 12.19, include the actual amounts for 2020 and the projected amounts for Year +1 to Year +6 for the income statements, balance sheets, and statements of cash flows for Walmart (in millions). In this portion of the Integrative Case, we use the projected financial statements from Chapter 12 and apply the techniques in Chapter 14 to compute Walmart’s required rate of return on equity and share value based on the value-to-book valuation model. We also compare our value-to-book ratio estimate to Walmart’s market-to-book ratio at the time of the case to determine an investment recommendation. In addition, we compute the value-earnings and price-earnings ratios, and we reverse engineer Walmart’s share price as of the end of 2020. The market equity beta for Walmart at the end of 2020 was 0.50. Assume that the risk-free interest rate was 3.0% and the market risk premium was 6.0%. Walmart had 2,821 million shares outstanding at the end of 2020, and the share price was $138.69.
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, 12.18, and 12.19, derive the projected residual ROCE (return on common shareholders’ equity) for Walmart for Years +1 through +6.
c. 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 +1 through +5.
d. 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.
e. Compute Walmart’s value-to-book ratio as of the end of fiscal 2020 with the following three steps:
f. Compute Walmart’s market-to-book ratio as of the end of 2020. 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?
g. Use the value-to-book ratio to project Walmart’s share value.
h. If you computed Walmart’s common equity share value using the dividends valuation approach in Integrative Case 11.1, and/or the free cash flows to common equity valuation approach in Integrative Case 12.1, and/or the residual income valuation approach in Integrative Case 13.1, 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 cases, you would benefit from doing so now.
Part II—Analyzing Walmart’s Share Price Using the Value-Earnings Ratio, Price-Earnings Ratio, and Reverse Engineering
i. 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 fiscal 2020. Using this Year +1 earnings-per-share forecast and the share value computed in Requirement g, compute Walmart’s value-earnings ratio.
j. Using the Year +1 earnings-per-share forecast from Requirement j and using the share price of $138.69 at the end of fiscal 2020, 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 f?
k. Reverse engineer Walmart’s share price at the end of fiscal 2020 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 +6 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 market price of $138.69 per share.)
l. Reverse engineer Walmart’s share price at the end of fiscal 2020 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 market price of $138.69 per share.)
Please format your paper in APA style with Times New Roman font size 12 and double-spaced. Include a title page with the necessary information and identify which questions you are answering in the main body. Remember to cite your sources in-text using APA format and provide a reference page. In addition, identify the questions you are answering in your submission; however, do not include the prompts.