1.

Introduction Wal-Mart
Wal-Mart was founded by Sam Walton on 1962 and it is the largest retailer in the world. The company has three major operations which are Wal-Mart Stores U.S., Sam's Club, and Wal-Mart International. On 2007, Wal-Mart used this new slogan Save Money Live Better. However, there are some critics about their employee life. Wal-Mart exploits their employees salary for setting low price to customer. They resisted their worker to build union organization because they tried to prevent from negotiating with employee. Nevertheless, Wal-Mart is still successful in the business because they attract lots of urban and rural consumers.

Costco
Costco was founded by James D. Sinegal and Jeffrey H. Brotman on 1983 and it is the largest membership warehouse club. Their goal is to provide low price products to customer as same as Wal-Mart. The difference between Wal-Mart and Costco is the strategy they use. Costco doesnt offer plastic bag to customer so customer need to bring bags by themselves. Furthermore, the high order volume is another reason why Costco can lower the cost and price because they can negotiate with supplier.

2. Ratio Analysis
a. Activity Ratios: It is used to evaluate asset utilization and turnover days. It also implies how well company operates its fixed asset and inventory in operating system.

Wal-Mart
20.0x 15.0x 10.0x 5.0x 0.0x Inventory Turnover Total Asset Turnover 2005 7.7x 2.5x 2006 7.7x 4.3x 2.4x 2007 8.0x 4.2x 2.4x 2008 8.3x 4.1x 2.4x 2009 8.7x 4.2x 2.5x 2010 9.1x 4.1x 2.4x 2011 9.1x 4.0x 2.4x 2012 8.7x 4.1x 2.4x

Fixed Asset Turnover 4.5x

Costco
25.0x 20.0x 15.0x 10.0x 5.0x 0.0x Inventory Turnover Fixed Asset Turnover Total Asset Turnover 2005 7.1x 3.3x 2006 7.4x 3.5x 2007 7.1x 3.5x 2008 7.3x 3.6x 2009 6.7x 3.3x 2010 7.0x 3.4x 2011 7.5x 3.5x 2012 7.6x 3.5x

12.1x 12.3x 11.9x 12.8x 11.9x 12.3x 12.7x 12.5x

Conclusion: Costco has really well operating efficiency according to its higher operating ratio. Furthermore, Costco not only maintain the ratio but increase it from 2005 to 2012. By contrast, Wal-Mart has obviously lower ratio in fixed asset turnover because Wal-Mart keeps buy equipment and property for expanding market. To short, Costco has better management in the use of asset and better improvement in the ratio trend. a. Liquidity Ratios: It can analyze the ability of paying expense in the short term. The higher current ratio and quick ratio mean the company has higher ability for exchanging asset to cash. The higher conversion cycle means they need more time to exchange the cash.

Wal-mart
1.0x 0.8x 0.6x 0.4x 0.2x 0.0x Current ratio Quick ratio Cash conversion cycle 2005 0.9x 0.2x 0.3x 2006 0.9x 0.2x 0.4x 2007 0.9x 0.2x 0.4x 2008 0.8x 0.2x 0.4x 2009 0.9x 0.2x 0.4x 2010 0.9x 0.2x 0.5x 2011 0.9x 0.2x 0.4x 2012 0.9x 0.2x 0.4x

Costco
1.4x 1.2x 1.0x 0.8x 0.6x 0.4x 0.2x 0.0x Current ratio Quick ratio Cash conversion cycle

2005 1.2x 0.6x 0.3x

2006 1.1x 0.4x 0.2x

2007 1.1x 0.5x 0.2x

2008 1.1x 0.5x 0.2x

2009 1.1x 0.5x 0.2x

2010 1.2x 0.6x 0.3x

2011 1.1x 0.5x 0.3x

2012 1.2x 0.6x 0.2x

Conclusion: Wal-Mart and Costco have the similar ability to pay cash because both of them are categorized to retail industry. It means their cash liquidity will be very high. Wal-Mart has a little bit higher cash conversion cycle than Costco as a result of its company size. Moreover, Wal-Mart has pretty lower quick ratio than Costco that means Wal-Mart dont control their cash position efficiently. For retail industry, cash liquidity is really important because retailer need to focus on inventory systems that need lots of cash to cover the system. b. Solvency Ratios: It describes how company uses their resource to manage fixed cost financing. The higher ratio means company takes higher risk in financing.

Debt to Asset
50.0% 40.0% 30.0% 20.0% 10.0% 0.0% 2005 4.6% 2006 28.0% 3.2% 2007 25.7% 11.3% 2008 27.3% 11.3% 2009 25.8% 10.1% 2010 24.3% 9.8% 2011 27.6% 8.7% 2012 27.6% 8.3%

Wal-Mart 25.8% Costco

Interest coverage
140.0x 120.0x 100.0x 80.0x 60.0x 40.0x 20.0x 0.0x Walmart Costco

2005 14.6x 43.0x

2006 13.2x 130.1x

2007 11.3x 27.2x

2008 10.5x 19.4x

2009 10.4x 16.5x

2010 11.7x 18.5x

2011 11.6x 21.0x

2012 11.4x 21.4x

Conclusion: According to debt to asset, Costco performs lower risk on its company. However, based on their standard analysis which Wal-Mart is 1.3% and Costco is 3% the result means Wal-Mart performs more stable ability than Costco. Even though Costco has lower ratio than Wal-Mart, it still has higher potential risk than Wal-Mart. On 2006 Costco suddenly has higher interest coverage because of its convertible bonds. If Investors convert debt to stock, it will decrease its debt and interest expense immediately. By comparing them from 2007 to 2012, Wal-Mart is still more stable than Costco although it has lower interest coverage. c. Profitability Ratios: This ratio reflects the companys earning ability directly. If the ratio is too low, it might make company go bankrupt or operating trouble.

Wal-Mart
25.0% 20.0% 15.0% 10.0% 5.0% 0.0%

2005 9.6%

2006 6.0% 9.1%

2007 5.9% 8.8%

2008 5.9% 8.8%

2009 5.6% 8.7%

2010 5.9% 9.1%

2011 6.1% 9.1%

2012 5.9% 8.9%

Net profit margin 6.1% Return on assets

Return on equity 22.4% 22.3% 21.3% 20.4% 20.5% 21.3% 22.1% 22.3%

Costco
16.0% 14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%

2005 5.8%

2006 2.7% 6.0%

2007 2.7% 5.9%

2008 2.8% 6.2%

2009 2.5% 5.2%

2010 2.6% 5.6%

2011 2.7% 6.0%

2012 2.7% 5.9%

Net profit margin 2.8% Return on assets

Return on equity 12.8% 12.2% 12.1% 14.4% 11.3% 12.6% 13.1% 12.7%

Conclusion: Wal-Mart has higher net profit margin even economy is fact recession. The most reason is It is not only keeps expand its stores in United State but in the world. Wal-Mart almost increases 100% store growth from 2005 to 2012. That is another reason why Wal-Mart has more debt than Costco. By contrast to Wal-Mart, Costco only increase 36.7% store growth within 8 years and is almost located on United State. On the other hand, Wal-Marts ROE is almost as twice as Costco. In the financial analysis, ROE can be described to the companys growth rate. That is, Wal-Mart has higher profitability and growth than Costco.

3. The process of calculation

The way I use to evaluate share price is Enterprise Value to Sales. This way can ignore growth rate that I need to predict when I use Golden Growth.

Firstly, I use historical data to calculate FCF/Revenue and make average. Furthermore, Capital IQ offers the predicted revenue data and I combine it with average FCF/Revenue. In other words, I get projected free cash flow. Secondly, Ibbotson and Capital IQ provide their bond rating, capital structure, average historical long term risk free rate and beta. The reason I use historical risk free rate rather current rate is that it is more stable. According to above information I can find the cost of debt and cost of equity. Moreover, the effective tax rate can be found in their annual report. That is, I calculate the WACC finally. Thirdly, I use EV to Sales ratio in 2011 for the base and use this ratio to multiply revenue in 2015 that I will get terminal value in 2015. Besides, I combine discounted free cash flow from 2012 to 2015 and add 4 year discounted terminal value. As share price is equity value divided by outstanding shares that I have to use enterprise value subtract long term debt to get equity value. To short, the advantage for using EV to Sales is that it can prevent from predicting growth rate inappropriately. After all, growth rate should be changed with economic situation and government policy and so on. It is not possible to maintain the fixed rate.

4. Estimated Firm Value--Wal-Mart

Historical Data

Date FCF Revenue growth rate Revenue FCF/Revenue Date FCF Revenue growth rate Revenue FCF/Revenue

2005 1,429.50 9.90% 284,310 0.50% 2009 9,772.40 7.20% 404,254 2.42%

2006 1,705.10 9.80% 312,101 0.55% 2010 13,633.10 0.90% 408,085 3.34%

2007 3,834.00 11.60% 348,368 1.10% 2011 7,363.60 3.40% 421,849 1.75%

2008 4,223.90 8.20% 377,023 1.12% 2012 9,330.50 6.00% 446,950 2.09%

FCF/Revenue Average1.608%

*unit in million
Projected Data

Date Revenue FCF

WACC

2012 446,950 9330.5

2013 469,185.59 7542.93

2014 490,418.83 7884.29

2015 512,987.5 8247.11

Costof debt =Historical Rf+ Spread rate = 4.5%+ 1.05%=5.55% Cost of equity =Historical Rf + beta*Rm-Rf= 4.5% + 0.34 * 5.5%=6.37% Effect Tax rate=32.6% Debt= $44070 Equity =$61.2*3400shares Enterprise= Debt+ Equity = $252,150 WACC=17.5% * 5.55% * (1-32.6%)+82.5%*6.37%= 5.9%
Use Enterprise value to sales estimation

WACC 5.91% Discounted terminal V 243698.77 Share price

2011EV to sales 0.6 FCF(present value) 28725.54 $67.16

PV 28725.54 Enterprise value 272424.31

Terminal V 306625.83 Equity value 228354.31

Conclusion: According to above information, I get the share price which is $

67.16. However, current share price is $61.2 that means Wal-Mart still has potential ability to increase. Wal-Mart is a largest retailer in the world and keep increase its market size. Furthermore, Wal-Mart combines variety of merchandise such as pharmacy, electrical equipment, furniture, food and so on. This way increases not only its competitors number but its competitive ability. The Best weapon Wal-Mart Has is its size. Nevertheless, It also might be its weakness. We can refer to its Debt to Asset ratio that indicates Wal-Mart having lots of pressure in the debt. When Wal-Mart keeps expand its commercial empire, it needs to increase the debt for turnover. In conclusion, Wal-Mart maintains its debt efficiently and stably until now. If the

ratio shows drastically change in the balance sheet that signals must be more dangerous than other alarms.

5. Estimated Firm Value--Costco

Historical Data

Date FCF Revenue growth rate Revenue

2005 694.8 10.1% 52,952.2

2006 570.6 13.6% 60,151.2 0.95% 2010 1,648 9.13% 77,946 2.11%

2007 803.2 7.1% 64,401 1.25% 2011 1,200.50 14.07% 88,915 1.35%

2008 450.1 12.5% 72,483 0.62% 2012 1,172.88 13.87% 93,396 1.26%

1.31% FCF/Revenue Date 2009 735.13 FCF Revenue growth -1.46% rate 71,422 Revenue 1.03% FCF/Revenue FCF/Revenue Average 1.235%

*unit is million
Predicted Data

Date Revenue FCF

WACC

2012 93,396 1172.88

2013

2014

2015 119,813.88 1479.46

104,257.19 111,801.26 1287.36 1380.52

Cost of debt =Historical Rf + Spread rate =4.5%+ 1.05%=5.55% Cost of equity =Historical Rf+beta * Rm-Rf= 4.5% + 0.65*5.5%=8.08% Effect Tax rate=35.3% Debt= $1380 Equity =$90.8*433.97 shares Enterprise= Debt+ Equity = $40784 WACC= 3.4% * 5.55%* (1-35.3%)+ 96.6%* 8.08%= 7.9%
Use Enterprise value to sales estimation

WACC 7.9% Discounted

2011EV to sales 0.46 FCF(present

PV 4592.99 Enterprise

Terminal V 54956.861 Equity

terminal V 43678.37 Share price

value) 4,592.99 $108.05

value $48,271.37

value 228354.31

Conclusion: Based on the evaluated share price, the result shows that
Costco is a worthy company for its potential up range. Costco has a really different strategy to Wal-Mart. It focus on customers loyalty and public praise when it decided to operate in member system originally but Wal-Mart focus on rural people and lower price that might not have loyalty and praise. This different strategy makes them go to different way and attract different customer. Costco has a lower capital size problem that might defeat its debt structure. On 2006, when it is the time to begin economic recession, Costco increases more percentage on debt than Wal-Mart. Moreover, Costco has a lower net profit margin and ROE that means it cant operate company in high earning and growth situation. To short, Costco should increase its international market for strengthening profit margin and revenue growth rate. Furthermore, it also needs to improve its vulnerable capital structure. Although Costco owns faithful client, it still needs to improve its narrow market concentration. In general, it is a buying stock for its famous and well member system.