University of Phoenix
FIN / 419 – Finance for Decision Making
November 3, 2009
Capital Valuation Paper
Companies are evaluated to determine if they are risky to invest in. There are many tools that are used to conduct this evaluation.
Part of determining Wal-mart’s financial health is to analyze their debt position. This is done by indicating the amount of other people’s money being used to generate profits. Long-term debts are also a factor of Wal-mart’s financial health. Long-term debt commits a company to a stream of contractual payments over a long period of time. For instance, the more debt Wa-lmart has, the greater the risk it is to pay back its contractual debt payments and perhaps becoming bankrupt. Shareholders often pay vey close attention to the company’s ability to payback their debt. The more debt a company uses creates greater financial leverage (Gitman, 2006).
The debt ratio demonstrates the proportion of total assets that the company has financed by creditors.According to Wal-mart’s annual balance sheet for the ending period of January 31, 2009 their total debt is $98,144,000, total assets $163,429,000(Yahoo, 2009). The equation for debt ratio is:
Debt ratio = Total Liabilities
The debt ratio for Walmart is
$163,429,000= 0.60 = 60%
This means that Walmart has financed more than half of its assets with debt. This is a high ratio, thus Walmart’s degree or indebtedness as well as its financial leverage is greater. Another debt ratio is the Times interest earned ratio which is earnings before interest and taxes / interest. The times interest earned ratio for Wal-Mart is $18,435,000 / $1,900,000 = 9.7. This looks good for Wal-Mart because a times interest earned ratio of 3 is decent and 5 is good.
In an effort to determine the real value of Wal-Mart common stock, multiple evaluation tools can be used. Comparison of Price-To-Book and Price-To-Earnings ratios give insight to the value of the stock price compared to reported earnings and reported asset values (book values). By comparing the corporation’s ratios to those of the industry average and other competitors, an understanding of appropriate ratios can be determined. In the case of Wal-Mart, the following spreadsheet shows a comparison to Costco, Target, and the industry average.
Compiled from Yahoo! Finance 11/2/09
From the data above, Wal-Mart’s Price to book ratio is well above that of Costco and Target. This difference shows an Wal-Mart’s common stock price is covering more debt per share than that of its competitors. A Price-To-Book ratio is not the most accurate representation of an organization, since the book values are only accounting for physical assets, and not the added value of knowledge or perceived value. Therefore a comparison of Price-To-Earnings ratios should be evaluated.
The industry average of Price-To-Book ratio is at 15.45. A ratio of 15.45 is considered to mean that the industry or company’s current stock price is expected to give returns over the next 15.45 years. Costco and Target both have ratios well above the industry average, while Wal-Mart’s Price-To-Book ratio falls below the industry average. Wal-Mart, valued at 14.74 years is considered more risky than its competitors. Wal-Mart’s current common stock price should fall below that of its competitors based on these ratios. However, Wal-Mart’s stock price is actually between that of Costco’s $57.75 per share and Target’s $49.34 per share at $50.28 per share. Based on this evaluation alone, Wal-Mart’s stock price is either over-priced or Target’s stock price is under-priced. To better understand the proper conclusion, Wal-Mart’s intrinsic value should be evaluated.
The intrinsic value is what investors consider the company to be worth. By evaluating the expected...