10.16      PREPARING AND INTERPRETING FINANCIAL STATEMENT FORECASTS. Wal-Mart Stores, Inc. (Walmart) is the largest retailing firm in the world. Building on a base of discount stores, Walmart has expanded into warehouse clubs and Supercenters, which sell traditional discount store items and grocery products.

 

Exhibits 10.11, 10.12, and 10.13 present the financial statements of Walmart for 2006–2008. Exhibits 4.50–4.52 (Case 4.2 in Chapter 4) also present summary financial statements for Walmart, and Exhibit 4.53 presents selected financial statement ratios for Years 2006–2008. (Note: A few of the amounts presented in Chapter 4 for Walmart differ slightly from the amounts provided here because, for purposes of computing financial analysis ratios, the Chapter 4 data have been adjusted slightly to remove the effects of non- recurring items such as discontinued operations.)

Required (additional requirements follow on page 862)

a.    Design a spreadsheet and prepare a set of financial statement forecasts for Walmart for Year +1 to Year +5 using the assumptions that follow. Project the amounts in the order presented (unless indicated otherwise) beginning with the income statement, then the balance sheet, and then the statement of cash flows. For this portion of the problem, assume that Walmart will exercise its financial flexibility with the cash and cash equivalents account to balance the balance sheet.

 

 

Â	2006	2007	2008
Cash	$     7,373	$     5,492	$     7,275
Receivables	2,840	3,642	3,905
Inventories	33,685	35,159	34,511
Prepaid expenses and other current assets	2,690	2,760	3,063
Current assets of discontinued segments	0	967	195
Current Assets	$ 46,588	$ 48,020	$ 48,949
Property, plant & equipment—At cost	115,190	127,992	131,161
Accumulated depreciation	(26,750)	(31,125)	(35,508)
Goodwill and other non-current assets	16,165	18,627	18,827
Total Assets	$151,193	$163,514	$163,429
Accounts payable—Trade	$  28,090	$  30,344	$  28,849
Accrued liabilities	14,675	15,725	18,112
Accrued income taxes and other current liabilities	706	1,140	760
Notes payable and short term debt	2,570	5,040	1,506
Current maturities of long term debt and leases	5,713	6,229	6,163
Current Liabilities	$ 51,754	$ 58,478	$ 55,390
Long term debt	30,375	33,402	34,549
Deferred taxes and other non-current liabilities	4,971	5,087	6,014
Total Liabilities	$ 87,460	$ 96,967	$ 95,953
Minority interest	2,160	1,939	2,191
Common stock + paid in capital	3,247	3,425	4,313
Retained earnings	55,818	57,319	63,660
Accumulated other comprehensive income	4,971	5,087	(2,688)
Shareholders’ Equity	$ 63,733	$ 66,547	$ 67,476
Total Liabilities and Equities	$151,193	$163,514	$163,429

                                                  

 

 

 

 

Â	2006	2007	2008
Revenues	$348,368	$378,476	$405,607
Cost of goods sold	(263,979)	(286,350)	(306,158)
Gross Profit	$ 84,389	$ 92,126	$ 99,449
Selling, general, and administrative expense	(63,892)	(70,174)	(76,651)
Operating Profit	$ 20,497	$ 21,952	$ 22,798
Interest income	280	309	284
Interest expense	(1,809)	(2,103)	(2,184)
Income before Tax	$ 18,968	$ 20,158	$ 20,898
Income tax expense	(6,354)	(6,889)	(7,145)
Minority interest in earnings	(425)	(406)	(499)
Income from discontinued operations	(905)	(132)	146
Net Income	$ 11,284	$ 12,731	$ 13,400
Other comprehensive income items	1,575	1,356	(6,552)
Comprehensive  Income	$ 12,859	$ 14,087	$   6,848

 

 

 

 

 

2006                  2007                  2008

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net Income $ 11,284 $ 12,731 $ 13,400 Add back depreciation 5,459 6,317 6,739 Other adjustments to net income 860 132 (146) Deferred taxes 89 (8) 581 (Increase) Decrease in receivables (214) (564) (101) (Increase) Decrease in inventories (1,274) (775) (220) Increase (Decrease) in accounts payable 2,132 865 (410) Increase (Decrease) in other current liabilities 588 1,034 2,036 Other operating cash flows 1,311 910 1,268 Net Cash Flow From Operations $ 20,235 $ 20,642 $ 23,147 Proceeds from sales of property, plant, and equipment 394 957 714 Property, plant, and equipment acquired (15,666) (14,937) (11,499) Investments (acquired) sold 267 (95) 781 Other investment transactions 542 (1,595) (738)   Â

Net Cash Flow from Investing Activities                                                 $(14,463)          $(15,670)          $(10,742)

                         

(Continued)

 

 

 

 

2006                  2007                  2008

 

Increase (Decrease) in short-term borrowing	(1,193)	2,376	(3,745)
Increase (Decrease) in long-term borrowing	1,101	2,101	827
Issue of capital stock	—	—	—
Share repurchases—treasury stock	(1,718)	(7,691)	(3,521)
Dividend payments	(2,802)	(3,586)	(3,746)
Other financing transactions	(510)	(622)	267
Net Cash Flow from Financing Activities	$ (5,122)	$ (7,422)	$ (9,918)
Effects of exchange rate changes on cash	97	252	(781)
Net Change in Cash	$       747	$ (2,198)	$  1,706

Note: The net changes in cash reported by Walmart do not reconcile exactly with the changes in cash balances each year because Walmart reclassifies prior year amounts of cash associated with discontinued segments.

 

 

Income Statement

Sales

Sales grew by 10.4 percent in 2006, 8.6 percent in 2007, and 7.2 percent in 2008. The com- pound annual sales growth rate during the last five years was 9.4 percent. Walmart gener- ates sales growth primarily through increasing same-store sales, opening new stores, and acquiring other retailers. In the future, Walmart will continue to grow in international mar- kets by opening stores and acquiring other firms and in domestic U.S. markets by convert- ing discount stores to Supercenters. In addition, despite vigorous competition, Walmart will likely continue to generate steady increases in same-store sales, consistent with its expe- rience through 2008. Assume that sales will grow 7.0 percent each year from Year +1 through Year +5.

Cost of Goods Sold

The percentage of costs of goods sold relative to sales decreased slightly from 75.8 percent of sales in 2006 to 75.7 percent in 2007 to 75.5 percent in 2008. Walmart’s everyday low- price strategy, its movement into grocery products, and competition will likely prevent Walmart  from  achieving  significant  additional  decreases  in  this  expense  percentage. Assume that the cost of goods sold to sales percentage will remain steady at 75.5 percent for Year +1 to Year +5.

Selling and Administrative Expenses

The selling and administrative expense percentage has steadily increased from 18.3 percent of sales in 2006 to 18.5 percent in 2007 to 18.9 percent of sales in 2008. Identifying and transacting international corporate acquisitions and opening additional Supercenters, together with the slowdown in the sales growth rate, will put upward pressure on this expense percentage. Assume that the selling and administrative expense to sales percentage will be 19.0 percent of sales for Year +1 to Year +5.

Interest Income

Walmart earns some interest income on its cash and cash equivalents accounts. The average interest rate earned on average cash balances was approximately 4.4 percent during 2008, similar to rates earned in 2006 and 2007. Assume that Walmart will earn interest    income

 

 

based on a 4.4 percent interest rate on average cash balances (that is, the sum of beginning and end-of-year cash balances divided by 2) for Year +1 through Year +5. (Note: Projecting the amount of interest income must await projection of cash on the balance sheet.)

Interest Expense

Walmart uses long-term mortgages and capital leases to finance new stores and warehouses and short- and long-term borrowing to finance corporate acquisitions. The average interest rate on all interest-bearing debt and capital leases was approximately 5.0 percent during 2007 and 2008. Assume a 5.0 percent interest rate for all outstanding borrowing (short-term and long-term debt, including capital leases, and the current portion of long-term debt) for Walmart for Year +1 through Year +5. Compute interest expense on the average amount of interest-bearing debt outstanding each year. (Note: Projecting the amount of interest expense must await projection of the interest-bearing debt accounts on the balance sheet.)

Income Tax Expense

Walmart’s average income tax rate as a percentage of income before taxes has been a steady

34.2 percent during the last two years. Assume that Walmart’s effective income tax rate remains a constant 34.2 percent of  income before taxes for Year +1 through Year +5. (Note: Projecting the amount of income tax expense must await computation of income before taxes.)

Minority Interest in Earnings

Minority shareholders in Walmart subsidiaries were entitled to a $499 million share in Walmart’s 2008 net income. Assume that the minority interest in earnings for Year +1 through Year +5 will remain a constant $499 million.

 

Balance Sheet

Cash

We will adjust cash as the flexible financial account to equate total assets with total liabili- ties plus shareholders’ equity. Projecting the amount of cash must await projections of all other balance sheet amounts.

Accounts Receivable

As a retailer, a large portion of Walmart’s sales are in cash or for third-party credit card charges, which Walmart can convert into cash within a day or two. Walmart has its own credit card that customers can use for purchases at its Sam’s Club warehouse stores, but the total amount of receivables outstanding on these credit cards is relatively minor compared to Walmart’s total sales. As a consequence, Walmart’s receivables turnover is very steady and fast, averaging roughly three days during each of the past three years. Assume that accounts receivable will increase at the growth rate in sales.

Inventories

Walmart has managed to increase the efficiency of inventory turnover ratio in recent years, in part because of the expanding role of grocery products in Walmart’s overall inventory. However, that increase in efficiency has been offset slightly by the stocking of new stores and the distribution of merchandise to stores worldwide. Inventory turns have increased from an average of 45 days in 2006 to 44 days in 2007 to 42 days in 2008. Assume that inven- tory will continue to turn over, on average, every 42 days, or roughly 8.7 times a year, in Years +1 to +5. Use this turnover rate to compute the average inventories each year and then compute the implied ending inventories each year.

 

 

Prepaid Expenses

Current assets include prepayments for ongoing operating costs such as rent and insurance. Assume that prepayments will grow at the growth rate in sales.

Current Assets of Discontinued Segments

Walmart’s balance sheets in 2007 and 2008 recognize amounts as current assets that are associated with discontinued segments (subsidiaries that Walmart is divesting). Assume that these amounts will be zero in Year +1 through Year +5.

Property, Plant, and Equipment—At Cost

Property, plant, and equipment (including assets held under capital leases) grew 11.6 per- cent annually during the most recent five years. The construction of new Supercenters and the acquisition of established retail chains abroad will require additional investments in property, plant, and equipment. Assume that property, plant, and equipment will grow 11.6 percent each year from Year +1 through Year +5.

Accumulated Depreciation

In 2007 and 2008, Walmart depreciated property, plant, and equipment using an average useful life of approximately 19.2 years. For Year +1 through Year +5, assume that accumu- lated depreciation will increase each year by depreciation expense. For simplicity, compute straight-line depreciation expense based on an average 20-year useful life and zero salvage value. In computing depreciation expense each year, make sure you depreciate the begin- ning balance in property, plant, and equipment—at cost. Also add a new layer of deprecia- tion expense for the new property, plant, and equipment acquired through capital expenditures. Assume that Walmart recognizes a full year of depreciation on new property, plant, and equipment in the first year of service.

Goodwill and Other Assets

Goodwill and other assets include primarily goodwill arising from corporate acquisitions outside the United States. Such acquisitions increase Walmart sales. Assume that goodwill and other assets will grow at the growth rate in sales. Also assume that goodwill and other assets are not amortizable.

Accounts Payable

Walmart has maintained a steady accounts payable turnover, with payment periods averag- ing ten times per year (an average turnover of roughly 35–37 days) during the last three years. Assume that accounts payable turnover will continue to turn over every 35 days in Years +1 to +5. Use this turnover rate to compute the average accounts payable each year and then compute the implied ending accounts payable each year. To compute accounts payable turnover, remember to add the change in inventory to the cost of goods sold to obtain the total amount of credit purchases of inventory during the  year.

Accrued Liabilities

Accrued liabilities relate to accrued expenses for ongoing operating activities and are expected to grow at the growth rate in selling and administrative expenses, which are expected to grow with sales.

Other Current Liabilities

Other current liabilities include primarily income taxes payable. For simplicity, assume that other current liabilities grow with sales.

 

 

Other Noncurrent Liabilities

Other noncurrent liabilities include amounts related to deferred taxes, health care benefits, and accruals for long-term expenses. Since 2006, other noncurrent liabilities have grown at an annual compounded rate of 10 percent per year. Assume that other noncurrent liabilities will continue to grow by 10 percent per year for Year +1 through Year +5.

Short-Term Debt, Current Maturities of Long-Term Debt, Capital Leases, and Long-Term Debt

Walmart uses short-term debt, current maturities of  long-term debt, capital leases, and long-term debt to augment cash from operations to finance capital expenditures on prop- erty, plant, and equipment and acquisitions of  existing retail chains outside the United States. Over the past three years, short-term debt and current maturities of long-term debt have fluctuated considerably from year to year, whereas long-term debt has grown fairly steadily at a compound annual rate of  6.0 percent per year. For simplicity, assume that short-term debt and current maturities of long-term debt will remain constant for Year +1 through Year +5 and that any additional borrowing will be in long-term debt (including capital leases). Assume that Walmart’s long-term debt will continue to grow at 6.0 percent per year in Year +1 through Year +5.

Minority Interest

Assume that minority interest will not change.

Common Stock and Additional Paid-In  Capital

Over the past three years, Walmart has increased common stock and additional paid-in capital by issuing shares to satisfy stock option exercises by managers, employees, and oth- ers. Common stock and additional paid-in capital have increased at a net compounded rate of roughly 15.3 percent per year during this period (net of payments to repurchase com- pany shares on the open market, which Walmart then reissues to satisfy stock option exer- cises). Assume that common stock and additional paid-in capital will grow at a net rate of 10 percent per year for Year +1 through Year +5.

Retained Earnings

The increase in retained earnings equals net income minus dividends. Walmart paid divi- dends amounting to $3,746 million to common shareholders in 2008, which amounted to roughly 30 percent of prior year net income. Assume that Walmart will maintain a policy to pay 30 percent of lagged net income in dividends each year in Year +1 through Year +5.

Accumulated  Other  Comprehensive Income

Assume that accumulated other comprehensive income will not change. Equivalently, assume that future other comprehensive income items will be zero, on average, in Year +1 through Year +5.

Cash

At this point, you can project the amount of cash on Walmart’s balance sheet at each year- end from Year +1 to Year +5. Assume that Walmart uses cash as the flexible financial account to balance the balance sheet. The resulting cash balance each year should be the total amount of liabilities and shareholders’ equity minus the projected ending balances in all non-cash asset accounts.

 

 

Statement of Cash Flows

Depreciation Addback

Include depreciation expense, which should equal the change in accumulated depreciation.

Other Addbacks

Assume that changes in other noncurrent liabilities on the balance sheet are operating activities.

Other  Investing Transactions

Assume that changes in other noncurrent assets on the balance sheet are investing activities.

Required (continued from page 856)

b.   If you have programmed your spreadsheet correctly, the projected amount of cash grows steadily from Year +1 to Year +5 and the projected cash balance at the end of Year +5 is a whopping $33,511 million (allow for rounding), which is more than

12.5 percent of total assets. Identify one problem that so much cash could create for the financial management of Walmart.

c.    Assume that Walmart will augment its dividend policy by paying out 30 percent of lagged net income plus the amount of excess cash each year (if any). Assume that during Year +1 to Year +5, Walmart will maintain a constant cash balance of $7,275 million (the ending cash balance in 2008). Revise your forecast model spreadsheets to change the financial flexibility account from cash to dividends. Determine the total amount of dividends that Walmart could pay each year under this scenario. Identify one potential benefit that increased dividends could create for the financial management of Walmart.

d.   Calculate and compare the return on common equity for Walmart using the forecast amounts determined in Parts a and c for Year +1 to Year +5. Why are the two sets of returns different? Which results will Walmart’s common shareholders prefer? Why?