Management

Part A Target Corporation: ROIC
For the fiscal year ending January 31, 2012, Target’s EBIT was $5,322,* and its tax rate was 34.3 percent. Its short-term borrowings were $3,786, and its long-term debt was $13,697. In addition, the firm’s book value of equity was $15,821.

1. Estimate Target’s return on invested capital or ROIC.
2. Compare it with Walmart’s. Are you surprised at the difference?

* All amounts related to Target are in millions of dollars, unless otherwise noted.

Part B Target Corporation: ROE
For the fiscal year ending January 31, 2012 (2011), Target had total revenues of (in millions) $69,865 ($67,390) and net earnings of $2,929 ($2,920). Its total assets were $46,630 ($43,705) and its equity was $15,821 ($15,487).

1. Estimate Target’s return on equity (ROE) for each of these two years, using the DuPont decomposition to indicate the profit margin, the asset turnover, and the firm’s financial leverage.
2. Why has the ROE changed?
3. How would you compare the ROE drivers for Walmart and Target?

Part C Target Corporation: Cost of Capital
According to its annual report, as of January 31, 2012, Target’s borrowing costs averaged 4.6 percent, and its tax rate was 34.27 percent. A research report estimated Target’s cost of capital at 10.5 percent. The firm had interest-bearing debt of $17,483. Moreover, Target’s stock was trading at $50.81 per share, and there were 679.1 million shares outstanding. Now, let’s assume Target’s amount of debt is also a market value estimate of the debt. Let’s also assume the current debt and equity values are at Target’s optimal capital structure.

1. Based on market value estimates, what is Target’s cost of capital?
2. How does it compare to Walmart’s, and what explains the difference?

Part D Target Corporation: EVA
Earlier, you were provided with the information necessary to estimate Target’s operating profit (EBIT) after-tax, also known as NOPAT; invested capital (the book value of equity plus interest-bearing debt); cost of capital; and market value of equity. Based on this information,

1. Estimate Target’s EVA for the year that ended on January 31, 2012.
2. Was Target adding value?
3. Did Target have a positive market value added or MVA?
4. How did Target’s EVA and MVA compare with Walmart’s EVA and MVA?

Part E Target Corporation: EV/EBITDA Analysis
Let’s suppose you forecast Target’s EBIT for the year ending January 31, 2013, to be $5,352, and you forecast Target’s depreciation and amortization to be $2,361. A research analyst determines that an appropriate forward-looking EV/EBITDA multiple for Target is 6.9 times. Based on this information,

1. Estimate Target’s enterprise value, or EV.
2. Next, incorporating the value of Target’s debt, estimate the firm’s value of equity.
3. Finally, based on 679.1 million shares outstanding, estimate the intrinsic value per share and compare it with Target’s stock price on January 31, 2012, of $50.81.
4. Based on this analysis, is Target’s stock overvalued or undervalued?

 

 

 

 

 

 

Target Corporation

 

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Part A

Target Corporation: ROIC                                                     

Target’s return on invested capital (ROIC) 20%. ROIC is a critical analysis of how a company efficiently allocates its capital to generate profits.  This calculation gives an idea of how profitable a company’s investments are. Wal-Mart’s ROIC is 8.56% (Edgar 2012).The difference between the two firms ROIC is huge and surprising. The difference may be trace back to the business models of the two firms. Wal-Mart’s business strategy is to appeal to the consumer with the lowest cost. Target strategy is geared towards maximizing on the profit margin while at the same angling to a more youthful image.   The industry average ROIC is 6.46% (Macro-trends, 2020). It is therefore apparent that Target is doing better than Wal-Mart due to a deliberate business model. The difference between the two retailers business model sees Wal-Mart generate more revenues returns a lower ROIC to its investors. Target on the other hand is dwarfed by Wal-Mart but the holders of its stock. The formula for calculating ROIC is (net income- dividend) divided by (debt+ equity)

 

ROIC= operating income _t (1- Tax rate) / Book value of invested capital t-1

= 5,322 ( 1-34.3) / 15,821.= 20%

Part B

Target Corporation: ROE

Using the DuPont decomposition to indicate the profit margin, the asset turnover, and the firm’s financial leverage, the ROE for target in 2012 was 18.51% (Macro-trends, 2020). However in 2011 the ROE was at a better 18.85%.  Return on Equity (ROE) is a measure to establish the percentage return of a company that the funds invested by shareholders.   A higher return simply means that the funds are being utilized much more profitably as opposed to the opposite.  The main reason why the ROE declined is that there was a declined in operating efficiency In Target the following year. This is reflected also by a marginal increase in net earnings despite all other parameters growing immensely. The size of the company grew but the growth was not reflecting an efficient use of capital.

Wal-Mart’s ROE has been historically low even when its competitors returned higher ROE. However that notwithstanding Wal-Mart has a higher price earnings ratio, 23.88 % that any of its competitors including target whose price earnings ratio is about 18.77% (Edgar 2012). This means that Wal-Mart is a very viable investment to value investors. ROE is a ratio. It is gotten by dividing net income by shareholders equity.

ROE= net income (annual) /shareholders equity

= 2,929/ 15,821 = 18.51% for year 2012

=2,920 / 15,487 = 18.83% for year 2011

Part C

Target Corporation: Cost of Capital

The Weighted Average Cost of Capital (WACC) for Target is 10.139%.   The WACC for Wal-Mart is 4.69% (Edgar 2012). A lower WACC means that a company can access capital to fund its operations rather cheaply. The huge difference is mainly because Wal-Mart has not been targeting stock to raise its capital which is expensive.  This could explain why Target has a higher ROIC in question one. This is to satisfy investor appetite. Target can lower its WACC by targeting debt funding more to raise capital as opposed to equity (Berk, et.al, 2013). This is because after tax of debt is significantly lower than equity. This would entirely change the capital structure. WACC is calculated by dividing the market value of a company by the market value of equity and debt, multiplied by cost of equity,  multiplied by the market value of the company’s  debt, multiplied by the cost of debt times 1 less the corporate income tax rate

WACC = Ke x proportion of equity + Kd(1-t) x proportion of debt

= Ke x E/(D + E) + Kd(1 – t) x D/(D + E)

Where:

Ke = cost of equity.

Kd(1 -t) = after-tax cost of debt.

E = market value of equity.

D = market value of debt.

10.5 x (50.81×679.1) /(17483+(50.81×679.1)+34.27(1-34.27)x 17483/(17483+(50.81×679.1) =10.139%.

 

Part D

Target Corporation: EVA

Target’s operating profit (EBIT) after-tax; NOPAT as at January 31, 2012 was 3496.55. Yes Target is target is adding value. However relying solely on NOPAT would be misleading since the figure does not capture one time losses and other non-recurring charges (Thibierge, & Beresford, 2015). This cost would adversely affect the yearly earnings. This would not be a true reflection of the operations of the firm. That notwithstanding, Target has returned an operating profit based on the data provided. Formula for NOPAT is operating profit x (1-Tax Rate)

Target has a positive market value. EVA is the difference between revenues and costs where the costs include expenses and cost of capital. Wal-Mart’s EVA was 5321. The EVA is an incremental difference on the return of WACC.  A positive EVA is a demonstration that a company is generating value with the capital invested. Wal-Mart has a higher EVA because it has higher revenue than Target this benefiting from economies of scale (Edgar, 2020). Similarly Wal-Mart has a bigger MVA than Target because of the sheer large amounts of revenue that it generates. Similarly the Wal-Mart with a higher EVA and MVA has a bigger impact on the economy that Target

NOPAT= net income + tax+ interest + non-operating gains (1-tax rate)

=5,322 +34.3 + (34.3x (13,697+3,786,)) +5322(1-34.3) = 3496.55

Part E

 Target Corporation: EV/EBITDA Analysis

The estimated enterprise value for Target is $30 billion.  The intrinsic value for Target is $ 35 billion. The value of Equity is $19 Billion. Based on this analysis, is Target’s stock overvalued or undervalued? The stock is overvalued.  When investors are buying the stock of a company, they do not only depend on the enterprise value and the value of equity. Most of the time, investors are more interested in the growth opportunities of the company. The business model of Target in this case plays a significant role in the pricing of the stock (Thibierge, & Beresford, 2015). Investors feel that the company’s prospects are good and as a result they are willing to pay a premium for it. Any positive outlook given by the company will result in an increment in the intrinsic value of the company regardless of the book value of the company.

 

 

 

References

Berk, J. E., Harford, J., Ford, G., Mollica, V., & Finch, N. (2013). Fundamentals of Corporate Finance. Sydney: P. Ed Australia.

Edgar, (2020).Wal-Mart financials, retrieved from https://www.sec.gov/Archives/edgar/data/1041169/0000104169190000/wmtform10-kx1312012.html

Macro-trends, (2020). Wal-Mart financial ratios, retrieved from www.macrotrends.net/stocks/charts/WMT/walmart/roe

Thibierge, C., & Beresford, A. (2015). A practical guide to corporate finance: Breaking the financial ice. Houndmills, Basingstoke, Hampshire; New York, NY: Palgrave Macmillan