Capital Structure Decision and Cost of Capital Case Study

Capital Structure Decision and Cost of Capital

My SLP Company of choice is Wal-Mart Stores. The other two companies I will be relying on for purposes of this discussion are Target Corp. And Costco Wholesale Corporation. Both companies happen to be in the same industry as Wal-Mart Stores. Most specifically, this text will compute the debt ratio and the debt-to-equity ratio of Wal-Mart Stores and discuss whether or not these ratios could be regarded too large or too small. Further, comparisons will be made between the debt-to-equity ratio of Wal-Mart Stores and that of its two competitors - Target and Costco.

The debt ratio in the words of Graham and Smart (2011, p. 44) is "a measure of the proportion of total assets financed by a firm's creditors." It is computed by dividing the total debt figure with the summation of equity and total liabilities. All the dollar figures below are in thousands.

Wal-Mart's debt ratio;

= total liabilities / (total liabilities + equity)

= $126,243,000 / ($126,243,000 + $76,862,000) = 0.62

Debt ratio for short-term liabilities;

= short-term liabilities / (short-term liabilities + equity)

= $71,818,000 / ($71,818,000 + $76,862,000) = 0.48

Debt ratio for long-term liabilities;

= long-term liabilities / (long-term liabilities + equity)

= $54,425,000 / ($54,425,000 + $76,862,000) = 0.41

When it comes to the debt-to-equity ratio, Graham and Smart (2011, p. 44) define the same as "a measure of the firm's financial leverage…." It is computed by dividing the total debt or liabilities figure with the representative total equity figure. All the dollar figures below are in thousands.

Wal-Mart's debt-to-equity ratio;

= total liabilities / total equity

= $126,243,000 / $76,343,000 = 1.65

Debt-to-equity ratio for short-term liabilities;

= short-term liabilities / total equity

= $71,818,000 / $76,343,000 = 0.94

Debt-to-equity ratio for long-term liabilities;

= long-term liabilities / total equity

= $54,425,000 / $76,343,000 = 0.71

The debt ratio of Wal-Mart as per the computations above is neither too high not too low. This is particularly the case given the industry Wal-Mart operates in. Retail and utility industries according to Quiry et al. (2011) have highly predictable and relatively stable cash flows. Thus in addition to being stable, cash flows in this case are not volatile. In that regard, Wal-Mart's debt ratio of 62% is largely.....