Introduction
Wal-Mart Stores is a multinational retailing company and one of the most giant corporations in the United States with revenue of approximately $480 billion. Wal-Mart operates a large discount variety store, grocery stores and hypermarkets in significant parts of the world thus making contributing to the high revenues incurred by the company. The Multinational Company is one of the recognized companies in the United States based on its ability to employee a high number of employees compared to other companies in the world. The company has approximately 2.3million employees distributed among groceries and the hypermarkets that are located in different parts of the world. This report will focus on the analysis of the Capital structure of the given multinational company through the application of relevant theories and principles. The analysis will focus on understanding the critical financial and business risks that are associated with nature of the capital structure of the company.
Capital Structure Issues
Capital structure involves ways implemented by the company to fund significant operations undertaken by the company. The company helps in defining the sources of funds that help the company to grow and experience an increased performance based on the operations undertaken. The capital structure of Wal-Mart Stores includes equity capital which forms the most significant part of the structure. However, the company involves some debts that help in financing operations taking places within the corporation in a bid to ensure smooth running and enhance growth. The value of the company has been unstable resulting from sentiments from the investors leading to a situation of fluctuations in the stock prices and thereby translating to a reduction of the debt rates. A reduction of debt in a given company may have some implications for the growth and development of the company. According to Apostol(2017), an optimal capital structure of a company incorporates both equity and debt financing to maximize the stock prices within a company.
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Wal-Mart Stores has implemented equity capital as the vital financing strategy within the company acting as the source of funding to that helps in undertaking the critical operations within the organization. Equity capital refers to a financing strategy that is earned from the insurance of stock and the accumulated earnings of a given company. In the equity financing strategy, the shareholders of a given company have the right to such funding. The equity capital of the company in 2016 was approximately $83.6 billion which was a reduction from the previous year which was approximately $85.9 billion. In the debt financing, Wal-Mart stores had a total of $38.2 billion as the long-term debts while the short term debts amounted to $2.7 billion (Liviu-Adrian, 2017). The given figures indicate that there is a decrease in the financial leverage of the company given the debt-to-capital ratio of the company. The debt-to-capital ratio of Wal-Mart as of 2016 was 0.34, which was a reduction from the previous years and that resulted from an increase in equity financing of the company that was not directionally constant.
Business and financial risks related to capital structure
The capital structure of a company is influenced by some factors that results in a given form of financing implemented by a company. Business risks factor is one of the leading factors that influence the nature of capital structure for a given organization. In any given business setting, the higher the risk, the lower the optimal debt ratio. The debt ratio capital structure of a company helps in defining the ability to meet specific responsibilities, thus attracting more investors. The nature of products or services offered by a given company may play an essential role in defining the level of business and financial risk facing a given company (Reinartz, S. J., & Schmid, 2015). The risks are determined by the stability of the revenue earned from the given sale of product or services within a company. Wal-Mart faces a business risk in its capital structure based on the fact that the revenues of the company are characterized by instabilities considering the nature of services and products offered.
Another major factor that influences the capital structure of a company is the financial flexibilities of a given company. The need to ensure that a company is financially flexible influences the decision-making processes concerning the capital structure mechanisms to be implemented by an organization (Öztekin, 2015). The capital structure of Wal-Mart is influenced by the need of being financially flexible by ensuring that the company can raise capital even in the bad times with low revenues from the sale of products. Lastly, the growth rate and opportunity influence the decisions towards implementing types of financing options that may be relevant in funding significant operations that help in ensuring growth of the company. According to Kumar (2005), companies experiencing growth opportunities tend to engage more in debt financing as the more comfortable option for funding operations within the company to experience the intended growth rate. In this case, Wal-Mart has already experienced a significant growth rate thus does not require to incur debts to finance projects within the company and implement the already earned revenue to finance the operations taking place within the company.
Modigliani and Miller’s [MM] capital structure theory
The Modigliani and Miller’s theory plays a significant role in defining the capital structure of a given company. The theory forms the basis of the modern and actual definition of capital structure in a given organization. The theory states that the value of a given company is not influenced by the nature of financing holding constant significant factors such as taxes and costs and considering an efficient market. The theory upholds that the efficiency of the market of the products and services helps to maintain the value of a given firm without the consideration of the nature of financing methods implemented by the company in financing the growth and development of the company. Although the theory intended to explain how company may be in a position to retain to retain its value regardless of the external and internal factors within a company, the theory faced some criticism based on its practicability.
Majority of the financial analysts argues that the theory is an irrelevant capital structure principle that may not be applicable in the modern financial world (Acedo-Ramirez, M. A., Ayala-Calvo, J. C., & Navarrete-Martinez, 2017). This argument forms the basis for the criticism considering that the theory was developed in a world that did not have taxes and run business freely without much costs that are required being met by a given firm. The central assumption of the theory is that there are times in a business operation whereby the taxes and other costs can overlook. The second assumption concerns the stability and the efficiency of given market, which may not be the case in an actual case scenario. In this case, the Modigliani and Miller’s theory is considered an irrelevant principle since there are efficient markets that exist in the world that does not have hindrances such as cost and other factors that influence the smooth running of the operations within a company.
Capital structure evidence and implications
A capital structure of a given company has significant impacts on the operations of a company and the overall performance. The methods implemented to finance the operations in an organization play a significant role in defining the growth and development of a company. There are financial implications that can be identified based on the capital structure presented by a given company. The first significant evidence of the capital structure is increased growth rates of the company despite the position of a company in a given market. Majority of the companies that experience steady growth and development in the level of assets are likely to have the debt financing which helps in providing ready funds to finance the assets and significant operations. The second evidence from the capital structure is the increase in the number of investors in the company, which is an element that indicates a reduction of the financial and business risks of a given company.
The firm’s optimal capital structure
Considering the analysis of the capital structure of Wal-Mart stores, it is evident that the company implements the equity financing based on the earned revenue of the company. The optimal debt ratio of the company is 0.34 thus indicating that the debt financing of the company is on the lower side compared to equity financing.
References
Acedo-Ramirez, M. A., Ayala-Calvo, J. C., & Navarrete-Martinez, E. (2017). Determinants of Capital Structure: Family Businesses versus Non-Family Firms. Finance a Uver , 67 (2), 80.
APOSTOL, L. (2017). OPTIMAL CAPITAL STRUCTURE-OBJECTIVE OF THE FINANCING DECISION. Lucrări Științifice Management Agricol , 19 (2), 177-184.
Kumar, J. (2005). Capital Structure and Corporate Governance. Xavier Institute of Management, India, unpublished paper , 51(1), 33-47.
Liviu-Adrian, Ț. A. G. A. (2017). An agency theory approach on Romanian listed companies’ capital structure. Theoretical and Applied Economics , 22 (3 (612), Autumn), 39-50.
Öztekin, Ö. (2015). Capital structure decisions around the world: which factors are reliably important?. Journal of Financial and Quantitative Analysis , 50 (3), 301-323.
Reinartz, S. J., & Schmid, T. (2015). Production flexibility, product markets, and capital structure decisions. The Review of Financial Studies , 29 (6), 1501-1548.
