Introduction
Walmart is a multinational corporation that operates in around 27 countries across the globe. The corporation operates numerous supermarkets with its headquarters in Arkansas. Sam Walton founded Walmart in 1962. The corporation has since opened more than 11,000 stores across the world. The corporation operates under numerous banners in different countries. Walmart is rated as the largest in terms of revenue. Moreover, Walmart Corporation employs the largest size of the workforce in the globe. The company employs more than 2.2 million employees across the world. This paper will explore the cost of capital for Walmart (Frank, 2006).
The market value or book value cost of capital?
The company should use the market value cost of capital since shareholders expect a return based on the market value of the company. Moreover, it should be noted that market value is prone to changes based on the performance of the corporation as opposed to book value, which works with initial investment into the company. These investments are usually rigid and thus do not reflect the dynamics of the market in its valuation. Market value provides the price of an asset in a competitive marketing environment.
On the other hand, book value gives the price of an asset as reflected in the company’s balance sheet. In essence, the market value provides the correct underlying value of assets based on hypothetical standards (Mohanty, 2012). In effect, market value is dissimilar to the price at which the asset can be sold. That is, it is discrete from the market price. When calculating the cost of capital, it should be noted that the cost measured is that of new capital, which is closely associated with market value as opposed to book value (Evans, 2015).
It should be noted that market value could equal market price when the business environment in which the company operates is both rational and efficient. On the other hand, book value comprises of cost of assets based on their initial acquisition value. In essence, the market value provides the best method of calculating the cost of capital since it recognizes the changes in the business environment brought about by competition, among other factors. Walmart should therefore use market value cost capital in its evaluation.
The same cost of capital for all business segments to evaluate their projects
Walmart is a multinational corporation; this portfolio makes it a global company with multiple businesses and brands. These multiple businesses are diversified across different parts of the world. Moreover, the businesses trade under varying business conditions based on the host country’s business environment. In this regard, it should be noted that companies with many different segments should apply the different costs of capital in evaluating their projects. Cost of capital should be done for each segment of the business because these segments operate in different countries, which represent different markets.
For instance, emerging economies present riskier cash flows than developed economies. That is, firms in developing countries would utilize higher discount rates than those in developed countries. Therefore, when the cash flows are valued separately using varying risk measures as well as different growth rates, the resulting aggregated value for the different businesses would provide a better cost of capital for valuation (Damodaram, 2009).
Nonetheless, this process is quite tedious, given that companies may have more than 70 brands in more than 30 countries. In this regard, companies with few segments should use the different costs of capital reflecting the value of their multiple segments. However, multinational companies like Walmart that outstretch most continents should use the same cost of capital to evaluate their projects by using weighted averages of risk parameters. Utilizing weighted averages can help in minimizing time wasted in valuing each segment. Nonetheless, the company should remember to adjust risk parameters accordingly to reflect changes in cash flows for its segments (Damodaram, 2009).
Investing in emerging markets and using the cost of capital
If the company has segments in a specific marketing environment, such as a developed market, then it should utilize the same cost of capital. However, when the company is involved in a different marketing environment, it should utilize the cost of capital that reflects the risk parameters in such markets (Tijdhof, 2007). For instance, emerging markets pose a greater market risk on capital than developed markets do.
High market risk causes companies to adopt high discount rates in the valuation of the business. It should be noted that market risk affects a company’s expected return. Moreover, these risks affect the cost of equity in emerging markets. In this regard, estimating the cost of capital in emerging markets requires utmost focus and expertise. High expertise is required because emerging markets do not have adequate market data for evaluation. Moreover, such business environments present great political, economic as well as financial risks (Grabowski & Harrington, 2010).
Investing in the emerging market poses great risks; these markets require different cost capital to achieve better estimations for the evaluation of the project. This is different from developed countries whose economies are already integrated into the global economy. In this context, companies with similar risks would utilize the same cost of capital. On the other hand, market volatility becomes central to the valuation of the cost of capital in emerging markets. Emerging markets would require high returns. Therefore, companies investing in emerging markets should use different cost capital that is based on the risks associated with their market (Grabowski & Harrington, 2010)
A small business’ estimation of its cost of capital
While multinational corporations evaluate the cost of capital with data from financial markets, small businesses lack adequate data for easy computation of the cost of capital. In this regard, appraisers usually emphasize discounted cash flow techniques. This happens because the cost approach ignores intangible assets such as reputation, experience, and relationships, which do not reflect in balance sheets. Moreover, the use of price multiples is also ineffective since most of these businesses are small and unique.
(Hal, 2016). This approach (discounted) is made by estimating future cash flows first; this is done after ascertaining that all expenses are made. In essence, if the fair market value is the discounted rate, then it becomes the cost of capital. Therefore, the discounted value represents the highest possible price. In essence, the cost of capital would reflect the weighted average of debt and equity financing sources. In determining the cost of debt, calculating leverage as well as interest coverage would assist. Moreover, the cost of equity would be determined by the capital asset pricing model (CAPM). If the business presents a high market risk, then the size premium also needs to be adjusted for the calculation of the cost of capital (Palliam, 2005).
Conclusion
The weighted average cost of capital (WACC) is essential in valuing companies. Companies like Walmart, which operate in different countries, should utilize similar WACC in developed economies. However, this cannot happen in emerging economies with high risks. Emerging economies would require the calculation of the cost of capital for specific segments based on the risk parameters of the market.
References
Damodaram, A. (2009). The Octopus: Valuing Multi-business, Multi-national companies. Web.
Evans, M. (2015). Calculating weighted average cost of capital. Web.
Frank, T. (2006). A brief history of Walmart. Web.
Grabowski, R., & Harrington, J. (2010). Cost of capital estimation in emerging markets. Web.
Hal, H. (2016). Valuing small businesses: The cost of capital. Web.
Mohanty, P. (2012). Why do we use Market-Value based weights while estimating WACC? Web.
Palliam, R. (2005). Estimating the cost of capital: Considerations for small business. Journal of risk Finance, 6(4), 335-340.
Tijdhof, L. (2007). WACC: Practical guide for strategic decision-making-part 1. Web.