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Financial Policy and Strategy

Target Inc. vs. WalMart Stores Inc.
Marianna Retzi Harris Tsalidis 11/28/2012

Target, headquartered in Minneapolis, Minnesota, is one of the major companies in the Discount and Variety Stores industry. This S&P500 company, based on its market cap ($41.07bil), is third behind Wal-Mart ($244.61bil) and Costco ($41.56bil). Target, which employs 365,000 individuals, first operated in 1902 as the Goodfellow Department Store in downtown Minneapolis under the direction of George Dayton an American business man and philanthropist. As of January 2012 Target operates in 1763 locations in 50 states. It offers clinic services (Target Clinic ), services concerning eye care (Target Optical ), pharmacy and photo services, as well as a portrait studio. Target operates six types of stores: Target, PFresh, Target Greatland, Super Target, City Target and Urban Target stores.
Products Target hardlines softines non-perishable groceries seasonal merchandise PFresh perishable and frozen food meat dairy backed goods deli items Target Greatland large selection of general merchandise very limited grocery selection Super Target Target and PFresh products Target Optical banks coffee shops restaurants City Target apartment essentials cosmetics groceries prescriptions clothing electronics toys Urban similar to Super Target products Source: http://www.target.com Average Size 8,800 m2 12,500 m2 Comments

8,800 m2 12,500 m2

14,000 m2 16,200 m2

starting to fade out

two entrances

5,100 m2

13,000 m2

in city centers, more than one storey

Who Owns/Runs your Firm?

84% of Target is owned by Institutional investors and mutual fund owners. Based on information from June 2012, the top 5 institutional shareholders in Target Corp are State Street Corp, Vanguard Group, MFS Investment Management K.K., Wellington Management Company and Fidelity Management and Research Company.

Source: http://investors.morningstar.com/ownership/shareholders-overview.html?t=TGT&region=USA&culture=en-us

Top 5 Institutional Stockholders

Instiution State Street Corp Vanguard Group, Inc. MFS Investment Management K.K. Wellington Management Company, LLP Fidelity Management and Research Company

Shares Held 60,989,642 32,329,096 27,721,004 21,513,854 13,337,707

% Total Shares Held 9.22% 4.89% 4.19% 3.25% 2.02%

Source: http://investors.morningstar.com/ownership/shareholders-major.html?t=TGT&region=USA&culture=en-us

One of the numerous functions of stockholders is to keep the managers in line so as to ensure that they put above their interests the protection of stockholders interests. This can take place in the 2

annual meetings (through voting). Unfortunately, big institutional holders have holdings in numerous companies and do not take the time to attend the annual meetings of every single company whose stock they own. As a result, it is very likely that there is poor protection of stockholders int erests. As far as private stockholders are concerned their percentage of the shares is non-influential. The largest private stockholder is the Chairman of the Board of Directors and CEO of the Target, Gregg W. Steinhafel with 269,924 shares (i.e. 0.0411% of total shares) (Appendix A, Figure 1) According to the Governance Risk Indicator, Target Corp.s Board of Directors, and corporate governance in general, is of low concern. The Board of Directors is comprised of only eleven (11) members and as a result more effective. The majority of the members (6) are between the ages of 60 and 70. The average years of membership on the Board are 10. Solomon D. Trujillo is the director with the longest membership on the Board of Directors. There is only one insider in the Board of Directors, the Chairman Gregg Steinhafel, who is also Targets CEO. In order to make the Board more involved with the company members of the Board of Directors are increasingly compensated with equity in the company. Unfortunately, the Chairman of the Board of Directors is also the CEO, consequently he cannot exercise control over himself. Finally, almost all of the Board members hold positions and stock in other companies too. (Appendix A, Figures 2, 3, 4, 5 & 6)

The Marginal Investor

A companys marginal investor is the investor more likely to trade their stock and influence the stock price. They usually own a lot of stock and trade a lot. In the case of Target Corp. 84% of the shares are held by institutional investors and mutual fund owners (1005 institutions). Fourteen out of fifteen of the top institutional investors have an international orientation and are thus globally diversified. As for insiders and owners they own less that 1%. The top 5 direct holders only hold 0.1064% of total shares. Breakdown % of Shares Held by All Insider and 5% Owners: % of Shares Held by Institutional & Mutual Fund Owners: % of Float Held by Institutional & Mutual Fund Owners: Number of Institutions Holding Shares: 1005 84% 0% 84%

Top 15 Institutional Investors

Amount Held


1 State Street Corporation 2 Vanguard Group Inc 3 Massachusets Financial Services 4 Wellington Management Company LLP 5 Blackrock Institutional Trust Company 6 Fidelity Management and Research LLC 7 Grantham Mayo Van Otterloo & Co 8 JP Morgan Chase & CO 9 Northern Trust Corporation 10 Brown Brothers Harriman & Company 11 Bank of New York Mellon Group 12 Barrow Hanley Newminney & Strauss LLC 13 TIAA-CREF Investment Management LLC 14 Invesco LTD 15 Norges Bank

60,989,642 32,329,096 27,721,004 21,513,854

9.31% 4.94% 4.23% 3.29%

international international international international

17,387,294 13,300,262

2.65% 2.03%

international international

11,072,551 10,943,532 9,866,500 9,175,514 8,803,344 8,734,880

1.69% 1.67% 1.51% 1.40% 1.34% 1.33%

international international international international international international




8,438,591 6,513,698

1.29% 0.99%

international international

Ownership, however, is not enough to determine the marginal investor. Looking at Targets transactions, institutional shareholders (www.morningstar.com) are equally active as insiders. However, since insiders hold a percentage of shares shy of 0.50% their transactions are not capable of influencing TGT. Taking into account all the information in our disposal the marginal investor is a diversified institutional investor. More specifically, there are numerous institutional investors. Unfortunately when

there are that many institutional investors there is a danger that no one controls the managers and there is likelihood that the objective of maximizing stock value will not be achieved. Major Direct Holders (Forms 3 & 4) Holder STEINHAFEL GREGG W TESIJA KATHRYN A SCOVANNER DOUGLAS A FRANCIS MICHAEL KOVACEVICH RICHARD M Shares 269,924 178,226 118,988 66,597 64,742 % Reported 0.0411% 0.0272% 0.0181% 0.0101% 0.0099% 0.1064% Sep 14, 2012 Mar 14, 2012 Mar 14, 2012 Jan 12, 2011 Dec 23, 2010

For a more complete point of view of the Board of Directors it would be useful to take a look at Targets Governance Risk Indicator (GRI ) as of November 1st, 2012: Audit Board Compensation Shareholder Rights Low Concern Low Concern Low Concern Low Concern

Source: http://finance.yahoo.com/q/pr?s=TGT+Profile

Market Risk Premium Estimation

Of all the models that connect risk and return the Capital Asset Pricing Model (CAPM) ( E(R)=RF+*(RM-RF) ) is the one that persists all these years because it is simple and does not require much information and is more effective in explaining future returns. In order to use this model we require three inputs: a) the current risk free rate, b) the market risk premium (difference between the expected premium for investing in risky assets and the expected premium for investing in riskless assets) and c) the beta () of the asset we are currently analyzing. (i.e. Target Corp) The second element in our CAPM analysis is the risk premium. That is, the premium that investors demand for investing in an average risk investment relative to the risk free rate.

Risk Premium = RM - RF For instance, in the case of a 3% risk premium we expect stocks to earn 3% more than the risk free rate. There are three ways to calculate the risk premium.

Survey Premiums
In the survey approach, investors, analysts or CFOs are asked to give their opinion about equity risk premiums. One of the best known surveys of its kind is the Global Fund Manager Survey conducted by Merrill Lynch for Bank of America. According to its February 14th 2012 issue, the survey premium is 4.08%. The survey approach is the approach least used since it is very volatile and is based on subjective input. It mostly represents hopes rather than expectations.

Historical Premium
There is no common methodology for calculating risk premiums through the historical premium approach. The historical equity risk premium is the premium that stocks earn over risk-free securities. (e.g T-Bills, T-Bonds) It is the most commonly used approach when wanting to use a premium. Depending on the average used (geometric or average), the type of financial instrument (T-Bills or TBonds) and the period of time used, historical risk premiums can have a rather wide range of values. For instance, when calculating the historical equity risk premium of stocks over T-Bonds using the geometrical average for the years 1928 - 2010 we get a figure of 4.31%. This approach though is not that effective in markets without historical data, in which case a modified approach is used.

Implied Equity Risk Premiums

The implied risk premium is a powerful and technical approach. Stock prices represent expectations for the future. And it is this look towards the future that makes this model preferable when compared to the ones mentioned before. We want an equity risk premium that looks into the future not the past and as a result we take the price of the stock index. (i.e S&P500) The implied equity risk premium is calculated by using the following formula: 6

Implied Equity Risk Premium = Expected Return on Stocks T-Bond Rate Based on the latest data available the implied equity risk premium for the US is 4.74%. The approach that is better suited for use in our analysis of Target Corp. is the last one since the implied equity risk premium looks in the future and not in the past. Of course, the smoother approach would be to take the historical of the implied risk premium in which case both the future and the past will be taken into account and we will be able to capture a potential credit crisis and thus give us better estimates. However, because its calculation presents various challenges, for the purposes of this paper we will use the simple implied equity risk premium of 4.74%. If we want to use a risk premium for a developed country (such as France or Germany) we will use the historical risk premium for that market. However, because very often there is not enough data for countries other than the US using a countrys risk premium can prove to be problematic. An alternative solution would be to use both equity risk premiums and do a mini analysis to spot the differences and figure out the one we prefer. Finally, in the case of an emerging market (e.g. China, India) the safest solution would be to use the risk premium of the United States combined with the risk country of the country in question.

Risk Regression Analysis

Through regression analysis we could be privy to important information concerning our stocks performance.

Jensens Alpha
Jensens alpha is a measure that is really important in evaluating our companys overall performance relative to the market. In order to calculate Targets alpha we will have to use the following formula: Intercept(risk free rate/n)*(1-beta) = Jensens Alpha Based on the regression analysis given by Bloomberg, the intercept for Target, which is a simple measure of performance, is 0.113%. For the risk-free rate we will use the rate of T-Bills instead of TBonds, since Jensens alpha deals with past performance, which is 2.7%. As for Targets beta it is 0.533. Beta is the slope of the regression and gives us information concerning risk. The market always has a beta of 1. Targets beta is smaller than the markets beta, which implies that TGT is a defensive stock since it is 46.7% less volatile than the market. The (risk free rate/n)*(1-beta) equals to (2.7%/52)*(10.533)=0.024%. The intercept equals to 0.113%. Since the intercept is larger than the product of the riskfree rate and 1-beta the stock did better than expected during the period that the regression was performed (i.e. it over preformed). Their difference is Jensens alpha and it is equal to 0.113%0.024%=0.089%. Since our data was weekly, annual Jensens alpha is 4.628%.

Market- vs. Firm- Specific Risk

Risk is broken down to market risk and firm specific risk. Market risk can be estimated from the companys R2. Targets market risk is 22.3%. The firm specific risk is what remains, i.e. 1- R2=77.7%. Firm-specific risk can be significantly reduced through an increase in the number of investments in Targets portfolio. On the other hand, market risk cannot be diversified and is part of the CAPM model.

Betas Historical Estimate

TGTs beta is 0.533. All regression parameters have an error estimate. Betas error estimate is 0.099 (i.e. betas standard deviation ()). After the regression Targets true beta is 0.533. An estimate with 67% confidence will be equal to (-)<<(+) (43.4%<<63.2%), while an estimate with 95% confidence will be equal to (-2)<<(+2) (33.5%<<73.1%).

Required Return
In order to estimate Targets required return in order to invest the CAPM will be used.

Expected Return = Risk-Free Rate + Beta * (Market Risk Risk-Free Rate) 10-year T-bonds will be used for our risk-free rate (1.625%). Targets beta is 0.533 and the implied risk premium for the US is 4.74%. My estimate for the required return on TGT is

1.625%+(0.533*4.74%)=4.15%. In order for any potential investors in Target to break even a return of at least 4.15% is required.

Target Corp (TGT)

intercept risk-free rate (T-bill) beta (risk free rate/n)*(1-beta) Jensens alpha R2 firm specific risk market risk SD of beta risk-free rate (T-bond) required return 0.113% 2.7% 0.533 0.024% 4.628% 0.223 77.7% 22.3% 0.099 1.625% 4.15%

Bottom-Up Beta
Beta, is a measure of systematic risk. It shows us the tendency of the companys tock to follows the ups and downs of the market. In other words, it shows us how volatile a stock is. There are two types of betas: the top down beta, which comes from a regression (and has more of a historical element in it) and the bottom up beta, whose calculation is a little bit more complex and which will be described below for Target Corp. in a few simple steps:

Step 1: Find out the businesses that your firm operates in and find the breakdown of your
firms businesses and basic details of each one of them in their annual report. Target operates in six distinct businesses and the companys annual report gives us information only about each business revenues. The information is presented in the following table:

Target Corp.
Business Household Essentials Hardlines Apparel and Accessories Food and Pet Supplies Home Furnishings and Dcor Credit Card Target 2011 Revenues $17.125 $13.015 $13.015 $13.015 $12.330 $1.370 $69.870

**all figures in billions**

Step 2: Estimate the unlevered betas for each business the company operates in. In order to
do so we should find the corresponding industries to Targets businesses. Based on the industry averages for the US we get the following unlevered betas. In the following table we have the businesses Target operates in, their corresponding US industries and the unlevered beta for these industries:

Target Corp.
Business Household Essentials Hardlines Apparel and Accessories Food and Pet Supplies Industry Sector Household Products Retail Hardlines Retail Softlines Retail/Wholesale Food 2011 Revenues Unlevered Beta (industry) $17.125 $13.015 $13.015 $13.015 $12.330 $1.370 $69.870 0.950 1.650 1.570 0.640 1.650 0.500

Home Furnishings and Dcor Furn/Home Furnishings Credit Card Target Financial Services

**all figures in billions**


Step 3: This step involves a couple of calculations. Ideally, we should compute the ratio of
enterprise value to sales with the following formula: Enterprise Value to Sales = (Market Value of Equity + Debt Cash)/Revenues However, because of lack of data on Target we will use the industry ratios for EV/Sales. Our next step will be to figure out the estimated value of each business based on those EV/Sales ratios. In order to do that, we will multiply the EV/Sales ratio with Targets revenues in 2011 for each one of its businesses. Estimated Value = (EV/Sales) * Revenues (for 2011) The final calculation for this step will be to compute weights by dividing the estimated value of each business to the estimated value of Target as a company (estimated value based on industry averages and not on Targets figures). Weight = Business EV / Targets EV

Target Corp.
2011 Revenues $17.125 Unlevered Beta (industry) 0.950 EV/Sales (industry) 2.210 Estimated Value $37.846


Industry Sector


Household Essentials Hardlines Apparel and Accessories Food and Pet Supplies Home Furnishings and Dcor Credit Card Target

Household Products Retail Hardlines Retail Softlines


$13.015 $13.015

1.650 1.570

0.830 0.870

$10.802 $11.323

12.71% 13.32%

Retail/Wholesale Food Furn/Home Furnishings











Financial Services

$1.370 $69.870



$9.138 $85.009

10.75% 100.00%

**all figures in billions**


Step 4: The fourth and final step would be to calculate the bottom-up unlevered beta for
Target by taking a weighted average of the previously mentioned unlevered betas. This is achieved by multiplying the industry unlevered betas for each business by the weights for each industry we computed in the previous step. Unlevered Beta (business) = Unlevered Beta (industry) * Weight

Target Corp.
2011 Business Industry Sector Revenue s Household Essentials Hardlines Apparel and Accessorie s Food and Pet Supplies Home Furnishings and Dcor Credit Card Financial Services Target $69.870 $85.009 100.00 % 1.1500 $1.370 0.500 6.670 $9.138 10.75% 0.0537 Furn/Home Furnishings $12.330 1.650 0.920 $11.344 13.34% 0.2202 Retail/Wholesal e Food $13.015 0.640 0.350 $4.555 5.36% 0.0343 Household Products Retail Hardlines Retail Softlines $13.015 $13.015 1.650 1.570 0.830 0.870 $10.802 $11.323 12.71% 13.32% 0.2097 0.2091 $17.125 Unlevere d Beta (industry) 0.950 EV/Sales (industry ) 2.210 Estimate d Value $37.846 Unlevere Weights d Beta



**all figures in billions**


The beta that we have just calculated ( unlevered = 1.1500) is the beta for Targets operating assets. However, a more useful beta to calculate would be that for all of Targets assets by using the following formula: Beta for Targets Assets = operating assets * ( ) + cash * ( )

This beta also includes Targets cash holdings. This beta, together with all of our previous findings are summarized in the following table:

Bottom Up Unlevered Beta for Disneys Assets

Business Household Essentials Hardlines Apparel and Accessories Food and Pet Supplies Home Furnishings and Dcor Credit Card Services Target Cash Balances Beta for Target's Assets Household Products Retail Hardlines Retail Softlines Retail/Wholesale Food Furn/Home Furnishings Financial Services Revenues in 2011 (TGT) $17.125 $13.015 $13.015 $13.015 Unlevered EV/Sales Estimated beta (industry) Value (industry) 0.950 1.650 1.570 0.640 2.210 0.830 0.870 0.350 $37.846 $10.802 $11.323 $4.555 Weights Unlevered Beta 0.4229 0.2097 0.2091 0.0343

44.52% 12.71% 13.32% 5.36%

$12.330 $1.370 $69.870

1.650 0.500

0.920 6.670

$11.344 $9.138 $85.009

13.34% 10.75% 100.00%

0.2202 0.0537 1.1500


**all figures in billions**

Targets regression beta (found on Bloomberg) is 0.533, while the beta for Targets assets is 1.14. This difference exists because the bottom up beta has a much lower standard error and takes into account not only the current situation but even expectations for the future.


Cost of Debt
The cost of debt is the rate at which a company pays its debt. We can find a pre- and after-tax cost of debt.

Interest Coverage Ratio

The simplest way of estimating a firms rating is through the interest coverage ratio. It helps us determine how easily a companys debt can be paid. The interest coverage ratio is calculated by dividing the companys earnings before interest and taxes (EBIT) by the companys interest expenses (for same periods of course). Interest Coverage Ratio = EBIT / Interest Expenses Targets EBIT for 2011, based on its 10K filing with the SEC, is $5.326 and its interest expenses for the same period are $0.869. Its interest coverage ratio is $5.328/$0.869 = 6.128. In simple terms this means that Target is able to meet its debt obligations 6.128 times over. This interest coverage ratio is quite high, which implies that Target is a safe company. Maybe too safe, in the sense that it is not taking enough risk (i.e. missing out on opportunities).

Synthetic Rating
Based on the interest coverage ratio Targets synthetic rating is calculated as being A+. This result is based on information from the table below. Since Target is a company with large capitalization ($41.07 billion) we base our results on the second column. So we have a synthetic rating of A+ and a typical default of 2.25%. However, using a synthetic rating here is not useful since synthetic rating is used only for companies that choose not to get rated. Target is a rated company and its rating according to Standard & Poors is also A+. Moreover, a synthetic rating can cause several problems, since it can be affected by exceptionally high or low earning years. Also it does not take into accounts all the financial information, rations and other quantitative and qualitative information that rating agencies take into account in order to assign ratings to companies.


Pre-Tax Cost of Debt

The pre-tax cost of debt is the sum of the risk free rate (10 yr US T-bond) and the default spread of the company. Pre-Tax Cost of Debt = Risk-Free Rate + Default Spread The 10 year US T-bond rate is 1.63% and the default spread of the company, based on its rating, is 2.25%. Targets pre-tax cost of debt equals to 1.63%+2.25% = 3.88%.

After-Tax Cost of Debt

The after-tax cost of debt, which is most commonly used since interest expenses are deductible, is the product of the pre-tax cost of debt and the difference of one minus the tax rate. After-Tax Cost of Debt = Pre-Tax Cost of Debt * (1 Tax Rate) Targets after-tax cost of debt is 3.88%*(1-34.30%) = 2.55%. Targets cost of debt is low, which is another indicator that this is a low-risk company. Following is a table with all of the relevant information concerning Targets cost of debt.


EBIT Interest Expenses Interest Coverage Ratio Synthetic Rating Rating (S&P) Default Spread (based on rating) Risk-free rate (T-Bond) Pre-Tax Cost of Debt Tax Rate After-Tax Cost of Debt

$5.325 $0.869 6.128 A+ A+

2.25% 1.63% 3.88% 34.30% 2.55%

Estimating Market Value

Market and Book Value of Equity
An equitys market value is the product of its shares outstanding times its current stock price. Target has a current stock price (23/11/12) of $64.48 and $41.96 bil./$64.48 = 0.651 bil shares outstanding. Its market value is $64.48*0.651 bil = $41.96 bil In other words, the market value of an equity is its market capitalization. The market value of equity portrays how the market values the company. However, what is more interesting and accurate is figuring out the value of the business itself. This can be found by dividing the market capitalization to shareholders equity. Targets shareholders equity is $15.47 bil. So Targets book value is $41.96 bil /$15.347 bil =$2.734. This is telling us that the company is trading at 2.734 times book value.


Market and Book Value of Debt

Targets book value of debt is the principal balance of its loans. Its total debt due is $28.218 bil. in book value terms. Its total interest expenses are $0.869 bil. In the following table we compute the maturity, which is 12.55, and our pre-tax cost of debt is 3.88%.

Due in 2012 2016 2017 2021 2022 2026 2027 2031 2032 2036 2037 Total

Maturity 5 10 15 20 25 26

Rate 2.8% 4.8% 8.7% 6.8% 6.3% 6.8% 4.6%

Amount Due $6,281 $4,604 $64 $680 $551 $3,500 $15,680

% due 40.06% 29.36% 0.41% 4.34% 3.51% 22.32%

Weighted Average 12.55 years

**all figures in millions**

The market value of debt of Target is calculated by using the following formula:

Market Value of Debt =


MV of Targets Debt =

) )

= $17.514.

Weights of Equity and Debt Based Upon the Market Value

In order to calculate the weight of equity based upon market value we will use the following formula using market value figures: 17

Weight of Equity = ($41.96/($17.514+$41.96)) = 70.55% In order to calculate the weight of debt based upon market value we will use the following formula using market value figures:

Weight of Debt = ($17.514/($41.96+$17.514)) = 29.45%

Weights for Equity and Debt Based Upon Book Value

In order to calculate the weight of equity based upon book value we will use the following formula using book value figures:

Weight of Equity =($2.734($28.218+$2.734)) = 8.83% In order to calculate the weight of debt based upon book value we will use the following formula using book value figures:

Weight of Debt = ($28.218/($2.734+$28.218)) = 91.17%

Cost of Capital
Cost of Capital = (Weight equity*Cost of Equity) + (Weight debt*Cost of Debt) =( ( ))) ) )

Based on figures previously mentioned the cost of capital is (market values are used since the cost of capital is determined by the market): ( ( ))) 18

) 0.04955+0.12636 = 5.71%

) = 70.55%*(1.62%+1.14*(4.74%) + 29.54%*3.87%*65.70% =

That is, Target must pay 5.71% as an average interest rate in order to finance its assets.


Wall-Mart Inc is an American multinational retailer corporation specializing in large discount department stores and warehouses. Currently is the worlds third largest public corporation (According to the Fortunes Global 500 list) with a current market cap of 253 billion dollars and is also in the first place in number of employers with approximately 2.2 million employees. Wal-Mart started as a family business by Sam Walton on June 3, 1940 and remains at the control of the Walton family up till now owning 48% of the stake in Wal-Mart. Wal-Mart also has Sams club a large retail warehouse club named after Wal-Marts founder Sam Walton.

Who owns/runs your firm?

Wal-Mart inc. is a family business with the Walton family owning 48% of Wal-Mart under the company Walton Enterprises LLC, next in the major institutional holders is Vanguard group Inc. with 2.64% followed by State Street Corp. with 2.26% then we have Blackrock Institutional trust company and Berkshire Hathaway Inc. owning 1.39% respectively (Data acquired from Bloomberg). As we see the Walton family owns the majority of shares by a large margin but looking at insider transactions

(http://finance.yahoo.com/q/it?s=WMT+Insider+Transactions) we see that they do not trade the stock at all. The marginal investor in Wal-Mart is the institutions that hold the remaining shares such as Vanguard Group Inc. Potential conflicts of interest are hard to happen in Wal-Mart with its current structure of owners. We have the Walton family owning 48% and then financial institutions each individually owning a much smaller percentage. We can assume that the institutions are not active investors and if they do not like something that the management does they will simply sell the stock and acquire another one instead. As well see from the board of directors Rob

Walton is the chairman of the board having no other positions in other companies so its primary interest is Wal-Mart. Below we see the full Board of directors for Wal-Mart and the interconnections they have with other companies (Generated from the corporate website of Wal-Mart and Forbes.com).

Wal-Mart board of Directors:

UnionBanCal Corporation Union Bank, N.A Cisco Systems Goldman Sachs Dell Inc News Corp Breyer Capital General Electric Co. Chubby Corp. Woolworths Limited

Aida M. Alvarez
McGraw-Hill Companies, Inc. Green Mountain Coffee Roasters, Inc.

M. Michele Burns
JPMorgan Chase & Co.

James W. Breyer
Yahoo Inc.

James I. Cash, Jr

Roger C. Corbett
Marriott International, Inc.

Douglas N. Daft

Timothy P. Flynn

Marissa A. Mayer

Steven S Reinemund

Arne M. Sorenson

The Williams Capital Group, L.P.

InnerWorkings, Inc.

Hyatt Hotels Corporation

Former WM CEO

Christopher J. Williams

Linda S. Wolf

Gregory B. Penner

H. Lee Scott, Jr.

Arvest Bank Group, Inc.

Chairman of the Board of Directors

Michael Duke

Jim C. Walton

S. Robson Walton


We see that there are members of the board of directors that are also members on other major companies such as Goldman Sachs, General Electric, JP Morgan and Yahoo Inc. Potential conflicts of interest are hard to happen with the current structure in the board of directors. Rob Walton is the chairman of the board and also a major stakeholder along with Jim Walton. We can observe some of the members having affiliations with technology companies, banks and private companies but nothing that directly threatens the interests of the company. Managers usually put their personal interests above stockholders but in Wal-Mart having the Walton family as active investors with 48% this is extremely hard to happen.

The marginal Investor:

Now well take a closer look at the ownership of Wal-Mart inc. (Data provided by Yahoo.finance.com)

Breakdown % of Shares Held by All Insider and 5% Owners: % of Shares Held by Institutional & Mutual Fund Owners: % of Float Held by Institutional & Mutual Fund Owners: Number of Institutions Holding Shares: 51% 31% 63% 1362

Major Direct Holders Holder Jim C. Walton John T. Walton estate trust Walton Alice L Walton Enterprises, LLC Walton S. Robson Shares 10,449,215 N/A N/A 1,609,891,131 N/A Reported May 31, 2012 Dec 7, 2011 Dec 7, 2011 Dec 7, 2011 Dec 7, 2011


As we see the insiders and owners of the firm have 51% of the company but this isnt enough to determine the marginal investor, we need to see if they trade the stock at all. This happen because the volume of transactions determine the true marginal investor not just the percentage held, maybe the Walton family hold 48% of the shares but do not trade them at all then its the institutions that serve as the marginal investor in this case. Lets take a look at recent insider transaction to have a clearer picture (Data provided from yahoo.finance.com)

Net Share Purchase Activity Last 6 months Insider Purchases - Last 6 Months Purchases Sales Net shares purchased (sold) Total insider sales held % Net shares purchased (sold) Shares N/A N/A N/A 1.71B 0% Trans 0 0 0 N/A N/A

Net Institutional Purchases - Prior Qtr to Latest Qtr Shares Net Shares Purchased (Sold) % Change in Institutional Shares Held (45,064,200) (4.57%)

From the above tables we can see that the insider trades are non-existent for the last 6 months so we can assume that they do not trade the stock much in comparison with the institutions that generated a 4.57% change in their holding shares for the last quarter. From our findings we see that the large majority of the firm (51%) is owned by the Walton family (in the form of Walton enterprises) and insiders but it seems that they do not trade the stock much so we can safely say that the marginal investor of Wal-Mart are institutions.


Estimating Market Risk Premium:

The market risk premium is simply the difference between the expected return of the market and the risk free rate and it is given by the formula: Return of the market minus Risk free rate equals the Market risk premium. It shows the minimum amount of return we should demand to compensate for our risk. It is an important input in our CAPM model, so we need to know the Market return and the risk free rate to determine it. We can estimate it with 3 methods which include the Survey approach, the historical premium approach (which is used by the most) and the implied premium. The survey approach is impractical so we take it out of the equation. Using the historical approach we use past data defining a period to analyze, it is important to note that the largest the sample the better for minimizing our standard error of the estimation. Since the formula is STD error of estimate = Annualized STD deviation is stock prices / Number of years in historical data we see that we need a large sample of years to minimize the standard error. Using historical data we have a snapshot of the past and we use that to make projections for the future. In our case for Wal-Mart inc. since its a company listed in the US the historical risk premium for 2011 is 4.31% The implied risk premium is a different method that uses dividend cash flows and stock buybacks to make future projections. Because dividend yield is the only guaranteed cash flow and companies rarely change their dividend policy we can make future cash flow estimates using wall street analysts estimates about the projected growth(for example 5%) then using trial and error with the interest rate(using IRR) to determine the expected return of stocks. The implied risk premium in our case for 2011 is 4.74%

What we will use for Wal-Mart Inc? These approaches we mentioned differ because due to the method used in historical risk premium it cannot capture a potential credit crisis in the market instead of implied premium which can provide us with better estimates. Due to the fact that it captures those crises so it gives riskier results making it more reliable in our case. What we would use for another developed market? (Germany for example) 24

In case we talk about a developed country and a company that is listed in that country then we will take the risk premium for that market and not the US risk premium. What we will use for an emerging market? For an emerging market we will take the US risk premium plus the given countrys risk premium

Risk Regression Analysis:

This is the regression results for Wal-Mart using two years and weekly data(less noise for the output)

To answer the question How well or badly did our stock do relatively to the market? we need to calculate Jensens Alpha for Wal-Mart which is a measure of performance relative to the market. It is given by the formula Jensens alpha = Intercept (Risk free rate/n)(1-Beta)


To calculate it we need these inputs: Risk free rate: Because Jensens alpha shows a performance of the past we are using US Treasury Bills instead of Treasury bonds. The rate of T-bills is 2.7% so thats our Rf rate. Intercept: This is our constant and a measure of performance, it is given by the regression and as we can see it is 0.321% for Wal-Mart Inc. Beta: Beta is a measure of risk, it is the slope of the regression and it shows how sensitive is our company relative to the market (Market always has a beta of 1). For example if out Beta is 1.2 then we saying that our stock is 20% more volatile than the market. Beta is given by the regression and in our case it is 0.356. So we have all the inputs to calculate Jensens alpha so the formula is: 0.321% -(2.7%/52)*(10.356 = 0.29% Note that we divide the risk free rate by 52 because we have weekly data now in order to find the annual we just multiply 0.29% by 52 to find the annual so we have 14.95% so we say that the Wal-Mart stock performed 14.95% better than expected. What proportion of your risk is market specific? What is firm specific? Moving on to see what proportion of our risk is due to the market we need to take a look at the R^2 of the regression. This is the amount of risk attributed to the market (market is the X variable) in other words how the X variable influences the Y. So we see that 15.8% is our market risk the remaining is firm specific. (1-R^2) gives us the firm specific risk which is 84.2% in our case. We need to note that only market specific risk is rewarded in the CAPM model and not firm specific. What is the historical estimate of beta for Wal-Mart stock? What range we will give with 67% and 95% probability? Now as we can see from the regression analysis the beta for Wal-Mart is 0.356 to find a range of estimates we know that 67% certainty means 1 plus/minus standard deviation and for 95% certainty 2 plus/minus standard deviation so we have 0.082 standard error of beta and we know the beta is 0.356 so: With 67% certainty: the range of possible returns is 27.4% << 43.8% With 95% certainty: the range of possible returns is 19.2% << 52% 26

Based on this beta, what is your estimate of the required return for this stock? Now that we have all inputs we can use the CAPM model to estimate the required return to invest in Wal-Mart. We use the 10 year Treasury bond rate for the risk free rate which is 1.625% (Data from Bloomberg) We know the beta from the regression and we also know the implied premium for US which is 4.74%. Now we can use the CAPM as: RF+Beta*(Risk premium) so we have 1.625+0.356*(4.74%) = 3.3% So this means that the investors need to make at least 3.3% to break even on Wal-Mart longterm if the stock is correctly priced and the CAPM is the correct model for risk.

Wal-Mart Bottom-up beta:

To estimate Walmarts bottom up beta well follow these steps: Break down our business into segments, for example Walmart is primarily a retail store but also has sam s club in the retail hard lines business. Then we ll compute the risk of being in that business by finding each segment s unlevered beta by using regression beta given from Bloomberg. After taking out the leverage we ll need to adjust this beta for cash so we ll continue by doing unlevered beta corrected for cash for each segment we operate. Then using industry average EV/sales(due to insufficient data we ll use industry averages) we ll assign weights by how much value we take from each segment Then we sumproduct the firm proportion with the unlevered beta corrected for cash to find the unlevered bottom-up beta. Then we adjust the beta again for financial leverage using the market D/E. Refer to this excel file for all the calculations and formulas (ctrl+` to show all formulas in cells). Complete excel file will be provided separately along with this.

<<Double-click it (may take a while to open)


So the bottom-up unlevered beta for Wal-Mart is 1.18. To find the beta for all Wal-Mart assets well compute a weighted average. So beta for Wal-Mart assets: 1.15

Cost of Debt:
The easiest way to estimate a firms rating (regardless from the official ratings if it is listed in the stock exchange) is through interest coverage ratio which can be calculated as follows:

Wal-Mart has an EBIT of 26,700$(all data refers to dollars in millions) and an interest expense of 2,004$ as of 2011 using http://yahoo.finance and WMT 10-K report as the source of financial

statements. So this makes for an interest coverage ratio of 13.31, meaning that Wal-Mart can fulfill its obligations 13.3 times over. Using the table below helps us to find a synthetic rating for our company depending on its Market cap and interest coverage ratio. The synthetic rating is used for companies that are not listed in the stock exchange thus having no official rating from the major rating companies (ex. Moodys). Synthetic rating in our case of a big multinational corporation with high market capitalization may be misleading because it does not take into account all the financial information and other industry related parameters.


So we see that Wal-Mart has a market cap of over 5 billion dollar and a synthetic rating of AAA so it has a default spread of 1.25%. This will help us find the Pre-tax cost of debt and the after-tax cost of debt using the synthetic rating. So the pre-tax cost of debt is calculated as follows: Pre-tax cost of debt = Risk-Free rate + default spread As a risk free well use the 10 year T-bonds rate at 1.625 we used earlier so we have 1.25+1.63= 2.88% is Wal-Marts pre-tax cost of debt. Now to find the after-tax cost of debt we use the formula: After-tax cost of debt = pre-tax cost of debt*(1-Tax rate) So in our case for Wal-Mart we have 2.88 %*( 1-24%) = 2.19% is Wal-Marts after-tax cost of debt. Note: Refer to the excel file for the complete table of calculations So to conclude with the cost of debt, we found Wal-Marts interest coverage ratio, synthetic rating and also pre-tax and after-tax cost of debt (using synthetic rating). If we have used book value instead to find the weights of debt and equity our calculations would be more reliable and conservative because book value is not as volatile as market value. Meaning that they do not change as often as market value and thus providing more conservative debt and equity ratios and for most companies using book value will yield lower cost of capital results.

Market Value:
The market value of publicly traded firms such as Walmart is easy to compute, we take the current trading price of the stock and we multiply it with the shares outstanding to find the market value of equity (or Market capitalization). For walmart the last closing price is 69.91 (as of November 26) and total shares outstanding of 3,361.44 so we multiply to find Walmarts market value to be 235 billion dollars. 29

Now using the data we can find well calculate Walmarts total market value of debt. Normally we need the interest rate walmart was given by the bank and the maturity dates so to bring it into present value. Unfortunately we do not have access to this information only for the total long term debt so well use that. Well use these numbers to estimate walmarts total market value of debt. The operating leases are calculated within the total debt(Date taken from: Walmarts 10-K annual report available on SEC) So we know the formula for Market value of debt is as follows:





Walmarts market value of equity: 69.91*3361.44 = 234,998 $ Walmarts total long term debt: 42,082 $ Walmart book value of equity: 3.295 $ To find the book value of equity we just divide the market cap with the total shareholders equity so for walmart we have 234,998 / 71,315 = 3.295 is the book value of equity for Walmart.

Column1 -2012 2012-2013 2012-2014 2012-2015 2012-2016 Thereafter Total Weighted avg:

Amount 3,095.00 $ 1,744.00 $ 4,295.00 $ 2,601.00 $ 4,273.00 $

Interest rate 3.50% 4.80% 3.90% 2.50% 2.30%

Maturity 1 2 3 4 5 6

% due 7% 4% 10% 6% 10% 62%

Weighted maturity 0.07 0.08 0.31 0.25 0.51 3.72

26,074.00 $ 5.40% 42,082.00 $ 4.60% 4.94


To find the Market value of debt we have all the inputs of the formula so it is: 97,051 $ Note: Walmart has debt issued in different currencies and maturities. Due to insufficient data we use the US dollar denominated for 6 years provided by the annual 10-K report.

To find the weights for debt and equity using the market cap we have: Weight of equity: 234,998/234,998+97,051 = 71% Weight of debt: 97,051/234,998+97,051 = 29%

Cost of Capital:
To compute the cost of capital well use the CAPM model using the bottom -up beta we found earlier (1.18) and the implied risk premium (4.74%). Well use the weighed equity and debt we calculated earlier Then we compute the cost of equity (CAPM) for WMT: risk free rate + beta*(risk premium) as we know it so: 1.63%+1.18*4.74% = 7.22% is the cost of equity for Walmart Now the final step is to compute the cost of capital which can be found as: Cost of capital = cost of equity * (equity/ (debt +equity)) + Cost of borrowing * (1-tax rate) * ((debt/ (equity +debt)) So for Wal-Mart we have a cost of capital of 5.74% (please refer to the excel file provided for the precise calculations) meaning that Wal-Mart must use a 5.74% as an interest rate for financing. If we have used book value instead to find the weights of debt and equity our calculations would be more reliable and conservative because book value is not as volatile as market value. Meaning that they do not change as often as market value and thus providing more conservative debt and equity ratios and for most companies using book value will yield lower cost of capital results.


Target vs. Wal-Mart: A Comparison

Target Marginal Investor Survey Historical Equity Risk Regression Beta Jensens Alpha Required Return Unlevered Beta 0.53 4.628% 4.15% 1.1500 Premium Wal-Mart

diversified institutional investor Institutions 4.08% 4.31% 4.74% 0.356 14.95% 3.3% 1.179 1.154 13.3 AAA 2.88% 2.19% $235 bill $3.295 bill $97,051 $42,082 5.74%

Beta for Companys Assets 1.140 Interest Coverage Ratio Synthetic Rating Pre-Tax Cost of Debt After-Tax Cost of Debt Market Value of equity Book Value of Equity Market Value of Debt Book Value of Debt Cost of Capital 6.128 A+ (same as S&P) 3.88% 2.55% $41.96 bil $2.73 bil $17.514 bil $28.218 bil 5.71%

We can see that Target and Wal-Mart have similar figures. It is obvious that Wal-Mart has a bigger share of the market. As far as risk is concerned all indicators point us towards the direction that both are low-risk companies.


Appendix A
Figure 1 Name Gregg W. Steinhafel James A. Johnson Roxanne Austin Calvin Darden Mary Dillon Mary E. Minnick Anne M. Mulcahy Derica W. Rice Stephen W. Sanger John G. Stumpf Solomon D. Trujillo Position Held Chairman of the Board Lead Independent Director Independent Director Independent Director Independent Director Independent Director Independent Director Independent Director Independent Director Independent Director Independent Director # of Shares 269,924 11,641 11,513 11,450 28,706 38,088 22,349 28,706 61,765 4,210 56,886 % 0.0411 % 0.0018 % 0.0018 % 0.0017 % 0.0044 % 0.0058 % 0.0034 % 0.0044 % 0.0094 % 0.0006 % 0.0087 %

Source: http://www.marketwatch.com/investing/stock/tgt/insiders?pid=14345883 http://finance.yahoo.com/q/it?s=TGT+Insider+Transactions http://investors.target.com/phoenix.zhtml?c=65828&p=irol-govboard http://www.reuters.com/finance


Figure 2


Figure 3
Name Gregg W. Steinhafel James A. Johnson Position Held Chairman of the Board Lead Independent Director # of Shares 269,924 11,641 % 0.0411% 0.0018% Other Companies Toro Company (small tools and accessories) Forestar Group (real estate) Goldman Sachs (diversified investments) Perseus LLC (merchant bank) Roxanne Austin Independent Director 11,513 0.0018% Abbott Laboratories (Pharmaceutical) Teledyne Technologies (Aerospace/Defense Products and Services) Cardinal Health (Drugs Wholesale) Darden Development Group Mary Dillon Mary E. Minnick Anne M. Mulcahy Derica W. Rice Stephen W. Sanger John G. Stumpf Solomon D. Trujillo Independent Director Independent Director Independent Director Independent Director Independent Director 28,706 38,088 22,349 28,706 61,765 0.0044% 0.0058% 0.0034% 0.0044% 0.0094% United States Cellular Corporation Lion Capital (investment firm) Johnson and Johnson Eli Lilly and Company (Drug Manufacturers - Major) Wells Fargo Pfizer Independent Director Independent Director 4,210 56,886 0.0006% 0.0087% Chevron Corp Wells Fargo & Company Western Union (Business Services) Position Held Chairman, Chief Executive Officer and President Independent Director Independent Director Vice President Independent Director President

Calvin Darden

Independent Director



Independent Director Chairman President and CEO Partner Independent Director CFO Independent Director Independent Director Independent Director Chairman, President, CEO Independent Director

Figure 4

Figure 5


Source: http://www.sec.gov/Archives/edgar/data/27419/000104746912005023/a2207783zdef14a.htm#de43801_gene ral_information_about_the___gen02948

Bibliography [Target]

Board of Directors | Target Corporation [Online]. Available: http://investors.target.com/phoenix.zhtml?c=65828&p=irol-govboard [14 November 2012] EDGAR Filing Documents [Online]. Available: http://www.sec.gov/Archives/edgar/data/27419/000104746912005023/a2207783zdef14 a.htm#de43801_general_information_about_the___gen02948 [14 November 2012] Global Fund Manager Survey [Online]. Available: http://m.friendfeedmedia.com/04baf510352828112e365c0a847d1e4cfb06bd4a [14 November 2012] Shareholder Overview for Target Corp [Online]. Available: http://investors.morningstar.com/ownership/shareholdersoverview.html?t=TGT&region=USA&culture=en-us [14 November 2012] Target 2011 Annual Report [Online]. Available: https://corporate.target.com/annualreports/2011/images/company/annual_report_2011/documents/Target_2011_Annual_R eport.pdf [14 November 2012] Target Corp (TGT.N) Quote | Reuters.com [Online]. Available: http://www.reuters.com/finance/stocks/overview?symbol=TGT.N [14 November 2012] TGT Competitors | Target Corporation Common Stock [Online]. Available: http://finance.yahoo.com/q/co?s=TGT+Competitors [14 November 2012] TGT Insider Actions for Target Corp. [Online]. Available:
http://www.marketwatch.com/investing/stock/tgt/insideractions [14 November 2012]


Bibliography [WalMart]

Board of Directors / Walmart [Online]. Available: http://corporate.walmart.com/ourstory/leadership/board-of-directors [Last Accessed: 14 November 2012] Board of directors profiles / Walmart [Online]. Available: http://www.forbes.com/profile/jim-walton/ [Last accessed: 14 November 2012] Financial Statements / Walmart. [Online]. Available: http://finance.yahoo.com/q?s=WMT [Last accessed: 14 November 2012] Financial Statements / Walmart [Online]. Available: http://www.reuters.com/finance/stocks/overview?symbol=WMT.N [Last accessed: 14 November 2012] Industry data / Retail stores [Online]. Available: http://people.stern.nyu.edu/adamodar/New_Home_Page/datafile/psdata.html [Last accessed 14 November 2012] Insider Transactions [Online]. Available: http://finance.yahoo.com/q/it?s=WMT+Insider+Transactions [Last accessed: 14 November 2012] Walmart bond data [Online]. Available: http://quicktake.morningstar.com/stocknet/bonds.aspx?symbol=wmt [Last accessed: 14 November 2012] Walmart annual 10-K report [Online]. Available: http://stock.walmart.com/financial-reporting/secfilings [Last accessed: 14 November 2012]