The Acquisition of ASDA by Wal-Mart

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The acquisition of ASDA by Wal-Mart on July 26, 1999 in reality began in 1991 when Archibald John Norman became the Chief Executive of ASDA (Wikipedia, 2005). The company, formed in 1965 by farmers from Yorkshire, fell upon difficult times in the late 1980’s and was transformed under the leadership of Mr. Norman as ASDA became the second largest supermarket chain in the United Kingdom. That transformation saw troubled ASDA develop into a savvy customer driven chain whose slogan was “permanently low prices forever” (Wal-Mart, 2000). This closeness to the Wal-Mart “Smiley faces everyday low price campaign” is not by accident states Allan Leighton, Chief Executive Officer of ASDA (Wal-Mart, 2000). The company began ‘borrowing’ Wal-Mart marketing staples such as ‘rollbacks’ and ‘volume-producing item’ (Wal-Mart, 2000). Thus, the acquisition of ASDA by Wal-Mart is one of almost identical corporate cultures and market image. Leighton said “The businesses are so similar…” they are “…almost spooky” (Wal-Mart, 2000).

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This synergistic climate fostered the Wal-Mart acquisition of ASDA. Wal-Mart became the world’s largest retailer by utilizing the time proven principles of economies of scale as well as detailed attention to employee retention, controlling costs and getting the most from every dollar spent, regardless of operating area. Contrary to some opinions Wal-Mart is not close to market saturation in the United States. It presently operates 1,353 discount stores, 1,713 super centers and 85 neighborhood markets generating $191.8 billion from these operations (Wal-Mart, 2005). The preceding does not take into account Sam’s Clubs (551), and international outlets (1,587). Thus, Wal-Mart’s acquisition of ASDA represents a long term strategy the company has been engaged in since 1991 when it opened its first foreign outlet in Mexico (Rowell, 2003). And the growth provided from foreign expansion has increased the company size to the point where it is over 4 times the size of the second largest retailer, Carrefour, and tops the Fortune 500 List as the world’s largest company (CNN Money. 2004).

Within the midst of this global expansion the ASDA acquisition by Wal-Mart has been termed by many analysts “…as the template for future global expansion” (Wal-Mart, 2000). Such a landmark business event thus serves as the basis for this paper. The field of corporate finance is extensive in terms of the accounting and finance areas it covers, as well as its applications. Be it expansion, plant and equipment financing, or mergers and acquisitions, to name a few, the variables that must considered and examined are vast in order that the acquiring company understand the financial structure, fiscal health, market positioning, competitive practices and corporate culture of the subject company. Market share is the objective of every business and that means growth. A company achieves this end through the application of a number of techniques, preferably in combination:

  1. increased sales
  2. expanded product line
  3. product innovations
  4. new product introductions
  5. expansion into new markets via:
    1. company introduction
    2. joint ventures
    3. mergers and/or acquisition

Today’s business climate requires companies to produce sustained growth in order to satisfy shareholder expectations of value, and this means employing economies of scale in operations to achieve internal savings that maintain price competitiveness, specially in the food retailing sector. The waves of consolidation have pointed to the utilization of mergers and acquisitions as the quickest means to achieve these ends when the conditions favor such. This means a company instantly gains presence in a market with established operations in place. In addition, the acquiring company adds significant assets to its operations as well. Financing such acquisitions means that the acquiring entity have the internal as well as external fiscal resources in place. Financing such activity can take one or all of the following forms:

  1. internal cash on hand
  2. funds raised by shares and or additional offerings
  3. leveraging of assets
  4. borrowing
  5. issuance of corporate stock

The selection of the one, part or all of the preceding, the percentage of each selected area that will be utilized to obtain the required figure and the resultant effects on the company’s financial well being after the acquisition are equations that must be examined and worked through prior to entering into such activity. Such is the nature of corporate finance, the means by which a company utilizes its fiscal resources to obtain the net result of increase market share, economies of scale, stabile operations and profitability.

Chapter 2 – Change Overview

In examining the conditions to acquire another company, the obvious aspect to be considered and equated is that of change’. Change that will occur:

  1. Within the acquiring company as a result of expanded operations in administration, logistics, accounting, legal, regulations, cultural adjustments, marketing, pa
  2. ckaging and personnel,
  3. In the acquired company in terms of acceptance of being a subsidiary and the resultant corporate culture adaptations, managing personnel, as well as uncertainty over the future and individual positions,
  4. Public and shareholder opinions concerning the proposed acquisition and how this will impact upon the corporate images of both companies,
  5. Competitive adjustments that will occur from this new threat.

The preceding requires that both companies have a thorough understanding of the far reaching ramifications that will accompany such an action and what adjustments, preparations and other measures they will need to undertake both internally as well as in the press, with suppliers and other sources to minimize and any negative connotations. How adequately and thoroughly both companies prepare for and execute the necessary aspects of the preceding broad categories are as important to the actual financial ramifications of the acquisition as they help to set the climate in which these firms will operate in the near future. Areas overlooked can potentially surface to impact negatively and thus affect the projected success of the acquisition in terms of returns, public opinion and market reactions.

Chapter 3 – Rational and Expectations

In the case of Wal-Mart the rational behind the acquisition of ASDA Group PLC was entrance to a new market to fuel growth, market share, achieve economies of scale and drive bottom line results. Said practice had been implemented on the part of the company starting in 1991 when it entered Mexico in a joint venture that eventually became an acquisition. That first foray was a practical learning experience for the company conducted almost within its own back yard. The closeness of the deal enabled Wal-Mart to keep tabs on problems and thus have a logistical as well as managerial advantage in being able to react and respond to the multitude of new developments that would or could surface operating in a foreign environment.

The practical foresight in conducting a close at hand foreign market entry minimized the potential for embarrassment resulting from errors, made even moreso by the relative unimportance of the country in and on the world stage. Subsequent entries into Puerto Rico, Canada, and other countries permitted Wal-Mart to gain valuable internal expertise to tackle increasingly competitive markets. The company rationale and expectations concerning this acquisition were stated by Wal-Mart International Division president John Menzer in indicating that Wal-Mart “… needs….the growth..” when in the future “… the United States (growth), slows down” (Rowell, 2003).

He added that “The United States…” represents “…37 percent of the world’s economy…” therefore leaving “…63 percent of international” growth (Rowell, 2003). Clearly, Wal-Mart was and is seeking growth via consolidation.

Chapter 4 – Financial Performance 

Company Liquidity 4.1 Disclosure Ethics

The ‘disclosure’ policy of public companies must conform to the standards and regulations as set forth by the respective governing bodies overseeing the trading and regulations for the stock market. In the United States this body is the Securities and Exchange Commission that sets forth specific rules requiring public companies “… to provide complete and comprehensive disclosure…” (Moulton and Rosen, 1999). In the United Kingdom the Financial Services Authority oversees the regulation of stocks listed on the London Stock Exchange. The disclosure rules are not as strict as those posed by the Securities and Exchange Commission in the United States and they set forth specifics concerning (Financial Services Authority, 2005):

  1. transferable securities,
  2. units in collective investment undertakings,
  3. money-market instruments,
  4. financial futures,
  5. forward interest-rate agreements,
  6. interest-rate, currency and equity swaps;
  7. options to acquire or dispose of any instrument falling into these categories,
  8. derivatives on commodities; and
  9. any other instrument admitted to trading on a regulated market in an EEA State or for which a request for admission to trading on such a market has been made.

The way in which the disclosure rules are laid out requires investors to have a strong working knowledge of the intricacies of this area. This loose interpretation has been challenged by Callum McCarthy the chairman of the FSA in a speech delivered on November 5 2004 which called for increased disclosure rules (FSA, 2004). Thus the question of morality with regard to companies supplying investors with scant information is governed by the rules set forth and therefore companies seek to present themselves in the best possible light and reveal what is required. The question as to whether this policy is in the public interest is undergoing review by the European Union. The recent scandals in the United States with respect to the failures and bankruptcies of large U.S. firms has created a new climate on the part of governments to set forth stricter rules and policies to safeguard the public. Financial reports for large corporations take on the name of ‘consolidated financial’ statements, which is the combination of all subsidiaries and operating companies within the corporation. The merging of this data shields details from any one company and thus protects weak performing units from all but the closest scrutiny. As the consolidated financial statements meet the rules of financial disclosure this practice is not illegal. However, in the case of large companies with multiple divisions and subsidiaries, important information can he lost in the maze of numbers and reporting techniques thus making the average investor’s task of understanding what profits and losses are attributable to which division as difficult if not nearly impossible.

4.2 Wal-Mart Post Merger

Wal-Mart trades as WAL on the London Stock Exchange at 2,497 p as of 8 October 2005 which is down from its February 2002 high of 4,425 p. The stock’s downward spiral since that time has been consistent. As the second largest UK food retailer it has been losing market share to rival Tesco whose market lead of 10% over ASDA points to their success. Worse still that gap between Wal-Mart / ASDA and Tesco is widening (Wikipedia, 2005). As Wal-Mart’s largest overseas holding, ASDA accounts for approximately half of its international sales which are reported to be over A£15 billion. Interestingly, a good part of the resurgance of J. Sainsbury has come at the expense of ASDA, thus the removal of Tony de Nuzio as the company’s Chief Executive Officer by Andy Bond in the early 1990’s (Wikipdeia, 2005). The driving force behind ASDA’s marketing campaign and image to consumers is as “… Britain’s lowest priced supermarket…” (Wikipedia, 2005), a claim that Tesco finally has managed to take away from ASDA / Wal-Mart for the first time in seven years (BBC News, 2005). ASDA’s marketing is not reaping the results the company is looking for and this has been reflected in the appointment of Sharon Osbourne to replace Julie Walters at the company. Based upon the in-depth information contained herein, as well as the relative positioning and successes of ASDA’s rivals, the stock is not recommended for acquisition unless one is seeking a speculative long term hold based on Wal-Mart’s marketing savvy being able to regain market share and make up ground on market leader Tesco over time.

4.3 Competitive Comparisons

The competitive market that Wal-Mart entered in its acquisition of ASDA consists of only four major firms in the super center category with a number of smaller operators. In order to more completely understand the dynamics of the merger, an understanding of the food retailing market in the United Kingdom is in order. 4.3.1 Wm Morrison Supermarkets PLC Wm Morrison became a major competitor in the UK supermarket wars via its acquisition of larger rival Safeway PLC in March of 2004 (Hoovers, 2005). That acquisition required Wm Morrison to best Tesco and ASDA in a hotly contested battle and it increased its number of stores from 125 to 550 (Hoovers, 2005). Ranked 4th in terms of turnover size in the United Kingdom food retailing market, the company presently has 360 supermarkets. Its marketing strategy is based upon conducting the basics of the business efficiently utilizing a low price format from large stores. Interestingly, Morrison has sold off the 114 Safeway Compact convenience stores to Somerfield while both Tesco and ASDA are expanding their presence into this market. Morrison’s stock performance over the past five years has fluctuated from 178 p to a high of 250 p and presently trades at 177.75 (Yahoo Finance. 2005). The company recently reported a 14% increase in sales at the converted Safeway stores and has shown steady sales increases since 2000:

Table 1 – Wm Morrison Supermarket PLC

Year Ended Turnover (A£ millions) Profit Before Tax (A£ millions) Profit After Tax (A£ millions)
30 January 2005 12,116 297.1 205.7
1 February 2004 4,944 319.9 197.6
2 February 2003 4,290 282.2 186.3
3 February 2002 3,915 243.0 143.7
4 February 2001 3,496 219.1 120.0
29 January 2000 2,969 189.2 103.1

The latest analyst recommendations for the company are as follows: Table 2 – Wm Morrison Supermarkets PLC Analyst Rating (Yahoo Finanzen, 2005)

Rating Analyst
Wm Morrison Supermarkets: Neutral JP Morgan
Wm Morrison Supermarkets: Under perform Goldman Sachs
Wm Morrison Supermarkets: Equal Weight Lehman Brothers
Wm Morrison Supermarkets: Out perform Credit Suisse First Boston

4.3.2 J. Sainsbury Listed on the London Stock Exchange as SBRY, at one time this chain was the largest in the United Kingdom. Today J. Sainsbury is the third largest chain in the UK and it has recovered from losses in market share to stabilize its operations (Wikipedia, 2005). The company’s new strategy was based upon overhauling its supply chain to solve the problems of stock availability, price competitiveness and improving customer service. The company’s financial performance since 1998 is as follows:

Table 3 – J. Sainburys PLC

(Wikipedia, 2005)

Year Ended Turnover (A£ millions) Profit Before Tax (A£ millions) Net Profit (A£ millions) Basic Eps (p)
26 March 2005 15,409 15 61 3.5
27 March 2004 17,141 610 396 20.7
29 March 2003 17,079 667 454 23.7
30 March 2002 17,162 571 364 19.1
31 March 2001 17,244 437 276 14.5
1 April 2000 16,271 509 349 18.3
3 April 1999 16,433 888 598 31.4
7 March 1998 14,500 719 487 26.1

Analyst ratings for the company are:

Table 4 –J Sainsbury PLC Analyst Ratings

(Yahoo Finanzen, 2005)



J. Sainsbury: Underweight Lehman Brothers
J. Sainsbury: In-Line Goldman Sachs
J. Sainsbury: Under Perform Credit Suisse First Boston
J. Sainsbury: Underweight JP Morgan

Clearly, analysts are not yet convinced of the company’s re-structuring efforts and the ratings reflect such. The company numbers 512 stores and has expanded into banking and financial services. It is this diversity that analyst feel caused the company to lose its focus on its core business, food retailing and the resultant crisis. The company’s share price has dropped from a high of 450 p in mid 2001 to a low of 220 p on February of 2003 and now trades at 283.50 p. 4.3.3 Tesco Britain’s largest retailer in global as well as domestic sales has managed to wrest the title of lowest priced supermarket chain from rival ASDA / Wal-Mart to add to the other successes it has had in the market place. With a 29% share of the market it leads ASDA / Wal-Mart by a full 10%. A survey conducted by The Grocer stated that the average shopping at Tesco came in at A£167.84 which was 0.4% less than for the same items at ASDA / Wal-Mart (BBC News, 2005). Tesco’s financial performance since 1998 has been as follows:

Table 5 – Tesco PLC

(Wikipedia, 2005)

Year Ended Turnover (A£ millions) Profit Before Tax (A£ millions) Net Profit (A£ millions) Basic Eps (p)
26 February 2005 33,974 1,962 1,366 17.72
28 February 2004 30,814 1,600 1,100 15.05
22 February 2003 26,337 1,361 946 13.54
23 February 2002 23,653 1,201 830 12.05
24 February 2001 20,988 1,054 767 11.29
26 February 2000 18,796 933 674 10.07
27 February 1999 17,158 842 606 9.14
28 February 1998 16,452 760 532 8.12

The company’s loyalty programs, Internet shopping service and customer satisfaction have enabled it to maintain its leadership position. On a global scale, Tesco oversees Internet grocery retail operations for U.S. based Groceryworks in which it has a 35% stake (Wikipedia, 2005). The company also has expanded into mobile and landline telephone services as well as it being an ISP. Tesco is also pursuing expansion through the acquisition of other companies. The company’s stock has risen after a drop in February 2002 to its current highs of (Yahoo Finance, 2005) and analyst’s favor the stock.

Table 6 – Tesco PLC Analyst Rating

(Yahoo Finanzen, 2005)



Tesco: Reduce Jyske Bank
Tesco: Reduce Jyske Bank
Tesco: Out Perform Goldman Sachs
Tesco: Overweight JP Morgan
Tesco: Out Perform Hypo Vereinsbank
Tesco: Overweight Morgan Stanley
Tesco: Kaufen Helaba Trust
Tesco: Overweight JP Morgan
Tesco: Overweight JP Morgan
Tesco: Upgrade Hypo Vereinsbank
Tesco: Kaufen Helaba Trust
Tesco: Overweight (Update) JP Morgan
Tesco: Overweight JP Morgan

Chapter 5 – Market Reaction to the Change

Wal-Mart has been surprising market analysts since its humble beginnings as a discount warehouse outlet that initially opened stores in rural areas. That foundation of providing its customers with low priced merchandise items across a broad spectrum of product types soon vaulted the company past then U.S. market leader K-Mart. John Menzer, the president of Wal-Mart’s international division states that the company “… needs….the growth..” when in the future “… the United States (growth), slows down” (Rowell, 2003).

Menzer goes on to add that “The United States…” represents “…37 percent of the world’s economy…” therefore leaving “…63 percent of international” gowth (Rowell, 2003). The double-digit gains the analysts have become used to from Wal-Mart have become increasing harder for the company to sustain in the U.S. market where it opens a new stores approximately once every 42 hours (Rowell, 2003). The company’s first move abroad in Mexico occurred in 1991, which was followed by Puerto Rico (1991), Canada (994), Argentina and Brazil (1995) continued with Jakarta (1996), China (1996), Germany (1998), South Korea (1998), the United Kingdom (1999), and then Japan (2002) (Rowell, 2003).

The phenomenon of Wal-Mart’s foreign expansion has been commented upon by Al Norman on ‘CBS 60 Minutes’, who stated that the company’s expansion into Mexico is a telling script on how it buys into existing operations rather than start from scratch (Rowell, 2003). The soundness of this strategy gives Wal-Mart a distinctive advantage in that by ‘buying into’ a foreign market it eliminates a competitor as well as obtaining a functioning operation that is known to consumers, along with trained employees and established outlets.

The Wal-Mart concept of large stores with massive inventories forces it to seek locations on the fringe areas of towns. The pull of a Wal-Mart causes people to drive thus taking them out of proximity with the in-town shops. This eventually creates a drawn on their business and to compete, in-town stores have to re-locate to approximate the Wal-Mart locations in order to maintain business. This cycle continues until the areas around super stores now support a variety of other business leaving the in-town shops suffering. Wal-Mart’s entry into the British arena has prompted a price war between it and larger British food retailing rival Tesco. Tesco’s real estate positioning in the market is superior to ASDA which Wal-Mart / ASDA is battling by discounting and expanding merchandise ranges as well as new store openings (Morning News, 2005). Wal-Mart’s stock price since the merger has dropped approximately 30% as the company pours more cash into market expansion, not just in Britain, but other markets it has entered as well.

Chapter 6 – Investor Ratios

Varied ratios permit investors, analysts and financial institutions to evaluate public companies against varied proven formulas. Taken as a whole, combinations of these ratios and formulas provide a look inside the maze of financial information by focusing on the key variables and their relationships to each other.

6.1 Ratio Analysis

Liquidity ratios measure the financial liquidity position on a specific day, such as when the Balance Sheet is completed. The resulting ratios help to measure the capability of the company to handle its short as well as long term obligations (CreditGuru, 2005):

  1. First Liquidity Ratio,

Is obtained by dividing ‘total current assets’ by ‘total current liabilities. The resulting ratio represents the ‘working capital’ of the current assets to meet current obligations (CreditGuru, 2005):

  1. ASDA 1998 (Compitition Committee, 2003)

The ASDA ratio of 2.978 remains fairly constant through 1999, the year of the acquisition, as would be expected since the company was in a normal operations mode, and had not undertaken any unusual or costly expansion, renovation or merger activities during this period. In fact it could very well be said that since the company was aware of the pending acquisition through talks with Wal-Mart, it might have delayed any activity that would have reflected negatively on the sale price out of responsibility to the company’s shareholders.

  1. ASDA 1999 (Compitition Committee, 2003)

The ratio for this year compares favorably with the ratio for 1998 as would seemingly be the case for a company understanding that it is in the midst of a merger. (3.0266)

  1. Wal-Mart 1997 (Shibui Markets, 2005)

The figures for the ‘First Liquidity Ratio’ remain fairly consistent for the years leading up to the acquisition. 1.642 represents the ‘First Liquidity Ratio’ for 1997.

  1. Wal-Mart 1998 (Shibui Markets, 2005)

The ‘First Liquidity Ratio’ for 1998 is 1.33

  1. Wal-Mart 1999 (Shibui Markets, 2005)

The ‘First Liquidity Ratio’ for 1999 is 1.26 The ratio does not increase due to the acquisition as a result of adding assets and liabilities that were in proportion from ASDA.

  1. Wal-Mart 2000 (Shibui Markets, 2005)

The ratio post merger figure shows a decline which indicates that the assets to liabilities benefits and obligations were in Wal-Mart’s favor as reflected by 0.99.

  1. Second Liquidity Ratio

The “Quick Ratio” is calculated by dividing ‘total quick assets’ by ‘total current liabilities. Quick Assets are those that can be easily converted to cash if they are not already in that form. It is represented by current assets less inventories (Investopedia, 2005).

  1. ASDA 1998

Data not available

  1. ASDA 1999

Data not available

  1. Wal-Mart 1997 (Wal-Mart, 2000)

The ‘Quick Asset’ figure for 1997 is 0.19.

  1. Wal-Mart 1998 (Wal-Mart, 2000)

The ‘Quick Asset’ figure for 1998 is 0.19

  1. Wal-Mart 1999 (Wal-Mart, 2000)

The increase in this number is a result of the ASDA acquisition, 0.24.

  1. Wal-Mart 2000 (Wal-Mart, 2000)

The ratio reduces slightly in conformity with a similar reduction shown by the First Liquidity Ratio for the same years (1999 and 2000), 0.17.

  1. Third Liquidity Ratio

The Debt to Equity Ratio is calculated by dividing ‘Total Liability (Debt)’ of a firm by ‘Owners Equity (Net Worth)’. This ratio permits the measurement of how the firm is managing the leveraging of its debt with respect to the capital being utilized (Investipedia, 2005). The formula provides information to determine that if the liabilities exceed the net worth, which would mean that the creditors have a bigger stake in the enterprise than the shareholders. It is computed by taking the ‘Total Liabilities’ and dividing it by ‘Owners Equity’

  1. ASDA 1998

Data not available

  1. ASDA 1999

Data not available

  1. Wal-Mart 1997 (Wal-Mart, 2000)

Wal-Mart’s ‘Debt to Equity Ratio’ for 1998 is 0.639.

  1. Wal-Mart 1998 (Wal-Mart, 2000)

The ‘Debt to Equity Ratio’ for 1998 is 0.782

  1. Wal-Mart 1999 (Wal-Mart, 2000)

The ‘Debt to Equity Ratio’ for the year of the merger remains constant, in conformity with the First Liquidity Ratio and ‘Quick Asset Ratio’ for these years, 0.793.

  1. Wal-Mart 2000 (Wal-Mart, 2000)

The ‘Debt to Equity Ratio’ increase slightly the following year to 0.998.

6.2 Net Income Comparisons to Industry Standards

The data for ASDA’s net income comparatives could not be found as much of the data is either unavailable or not found in the consolidated financial statements of Wal-Mart. Wal-Mart’s numbers for the period 1997 through 2000 are as follows (Wal-Mart, 2000):

  1. 1997 21%
  2. 1998 21%
  3. 1999 22%
  4. 2000 21%

The preceding numbers are close to the industry standard of 25.9% as determined by The Co-operative Group (Co-operative Group, 2005), an association of business individuals who formed this organization as a result of their common economic, cultural and social needs. Wal-Mart’s positioning as a low price retailer puts additional pressure on profits as a result of pricing, thus the preceding figures do not seem out of line with their market positioning both before and after the acquisition of ASDA Group PLC. 6.3 Share Price Comparison with FTSE According to the September 2005 FTSE UK Markets Review (FTSE Research, 2005) Food and Drug Retailers posted a share price performance of –3.9%. The industry grouping takes into account all publicly listed firms within the classification and as a group they represented one of the “5 Worst Performing Industry Sectors on the FTSE (FTSE Research, 2005).

6.4 Systematic and Unsystematic Risk Analysis

6.4.1 Systematic Risk Analysis A ‘systematic risk’ influences a broad spectrum of assets and can include the entire market. The other name for this term is “Market Risk” as a result of the aforementioned (Mississippi State University, 2003). Some examples of areas or aspects that can, and do affect the entire market are (Mississippi State University, 2003):

  1. Changes in the money supply,
  2. Inflation,
  3. GDP growth,
  4. Changes in tax rates, and
  5. War or regional conflicts

The sweeping ramifications of the foregoing, as a few select examples, will either immediately or eventually effect almost all of the firms within the market. One important consideration to keep in mind is that these ‘systematic risks’ can not be eliminated in terms of management measures, portfolio changes or other techniques. One either rides them out, cost averages down or waits until it (the risk) has run its course. The Markowitz Model states that the ‘investor’s total utility’ is based upon the assumption of an expectation of future wealth and the risk that is expected as a result of this. There are three fundamental results that typify optimum investment (Mississippi State University, 2003):

  1. Investors seek and prefer higher returns or lower returns,
  2. Investors want to avoid risk or minimize it wherever possible,
  3. and that there is a ‘diminishing marginal utility’ connected to the attainment of wealth.

6.4.2 Unsystematic Risk Analysis This type of risk affects either an individual firm, or a small quotient of financial assets as well as firms. It is also known as a ‘Market Specific Risk’ since it affects a specific area or firm. Another aspect of this risk is that it is also termed a ‘Diversifiable Risk’ in that it can be removed from a portfolio since it is a singular type of occurrence. Since ‘unsystematic risk’ is random the effect can be eliminated from a portfolio through diversification as this type of risk is usually offset by good events occurring in another firm or firms (Mississippi State University, 2003).

6.5 CAPM (Capital Asset Pricing Model)

The Capital Asset Pricing Model was developed by William F. Sharpe whose approach of a ‘heretical notion’ concerning investment risk as well as reward was the basis for it. Under this model there are two specific risks (Burton, 1998):

  1. The risk of being in the market, which Sharpe titled a systematic risk. This was later called ‘beta’ and it can not be removed by diversification.
  2. The second aspect of risk is the unsystematic risk which can be mitigated through diversification measures.

Sharpe calculated that the expected return of a portfolio is based on its ‘beta’, which is its relationship to the market overall. The Capital Asset Pricing Model aids in measuring portfolio risk and the return on said risk that can be expected for assuming it (Burton, 1998).

6.6 Beta

Termed a statistical measurement of volatility regarding a stock’s trading price in relationship to the price movement of the market overall, it is a useful theory that the average investor can and does utilize (Carlson, 2003). The following is what beta reveals about a stock (Carlson, 2003):

  1. Beta of 1

This indicates that the stock is market neutral, meaning that is neither carries less or more risk than the market overall. The stock will tend to move as the market moves, up or down.

  1. Beta that is greater than 1

Stocks falling within this category will either rise or fall faster than the market does. As an example, a stock whose ‘beta’ is 1.25 is forecast to move 25% more than the market, thus if the market rises by 1%, then the stock is expected to rise by 1.25%. The same is true in a decline.

  1. Beta that is under 1

A stock with a ‘beta’ that is less than 1 is projected to move less than the market does. A ‘beta’ of 0.8% means the stock is expected to move 0.8& in price when the market moves by 1%.

6.7 WACC

Known as the “Weighted Average Cost of Capital” this theory calculates the expected return to owners of equity and debt the cost of capital. WACC calculates the return that both the lenders and stakeholders can expect. In a discounted cash flow analysis the WACC is utilized as the discount rate that is applied to cash flows in the future to derive the net present value of the business. The WACC is also used as the hurdle rate via which to gauge ROIC performance (McClure, 2003).

6.8 Capital Gearing Ratios

Also known as ‘leverage’, gearing describes the components of long-term corporate funding that is internally provided by shareholders and contributed to externally by lenders. Utilizing ratio analysis to interpret financial statements requires more that just calculating key gearing ratios. The ratios are tools that provide a deeper insight of the company to aid in planning and decision making along with control (Anderson, 2000). The higher the degree of leverage within a company the more risky that company is. As is the case with most ratios the average level of ratios within an industry is considered the acceptable norm. Some of the more widely understood examples of gearing ratios are (Anderson, 2000):

  1. Debt to Equity Ratio,
  2. Times interest earned,
  3. Equity Ratio, and
  4. Debt Ratio


6.9 Pecking Order Theory

Under this theory, funds that are generated internally represent a firm’s first selection or choice, which is followed by debt and then equity as the third choice (Frank et al, 2000)

6.10 Static Trade Off Theory

The ‘Static Trade Off Theory’ basically consists of two versions and they both predict that companies have a capital structure that is optimal:

  1. The traditional version postulates the capital structure of a firm and is determined as a result of the trade-off in the tax benefits of debt and the costs expected as a result of financial distress. An optimal mix of debt and equity is obtained when “…the marginal present value of tax savings equals the marginal present value of financial distress costs.” (Irvine et al, 2000)
  2. The second version, which is termed ‘agency theory’, is a trade-off regarding the agency costs associated with an equity and the agency debt costs. An optimal debt-to-equity ratio minimizes the total agency costs.

Prior to the merger of ASDA Group PLC and Wal-Mart, ASDA paid out dividends when operational profits permitted. In addition, the employees participated in a share scheme whereby 7% of their paycheck go into the scheme and this is still active after the merger. The start of the fiscal year also marks the period when employees can elect to sell, buy as well as float their shares. The post merger climate has changed this to a small degree in that the ASDA employees are purchasing Wal-Mart shares (, 2005). By providing employees with a vested interest in the company they work for via share ownership, management receives a higher level of commitment and this has helped the company achieve its goals and objectives as set forth in customer service and quality as well as internal baking, sales and other aspects of business. 

7.1 Dividend Policy Theory of Modigiliani and Miller

In 1961 Modigiliani and Miller argued that the value of a company is independent of that company’s dividend policy (Estrada, 1996). The amounts of money that are paid out in dividend policy are in reality quite extensive. Thus the payment of dividends does deplete companies of cash which might be put to better use elsewhere. In those types of situations many firms opt not to pay out dividends in order to keep cash on hand. Thus there does seem to be a correlation, at least in the instances of some firms, whereby dividend policy is either linked or thought of in consideration of the company’s overall value

7.2 Dividend Policy Theory of Lintner

John Lintner (1956) developed this theory by utilizing two observational facts of dividend policy as the basis for correlation:

  1. That companies usually set long-run ratios regarding dividends tied to earnings and the amount of NPV projects which are available. NPV is a tool that evaluates investment decisions. Its primary advantage is the time value of money, calculation of uncertainty as well as the risks of the project that are inherent in its implementation (Odellion Research. 2004).
  2. And that earnings increases are not always a given, thus the dividend policy is not changed until new earnings levels are achieved and sustained.

Of these two differing views Lintner’s model takes a more pragmatic stance in that dividend policy is tied to corporate performance and long term stability rather than the need to pay out dividends for the sake of dividends.

8.1 Modigiliani and Miller

The ‘Capital Structure Irrelevance Theorem’ states that a firm’s “…capital structure does not affect firm value…” (Hill, 1996). Simply stated, a company can not increase the capital value of the enterprise by utilizing one capital structure in place of another as it is a static item. The assumptions put fo

rth by Modigiliani and Miller are as follows (Hill, 1996):

  1. Investment decisions are independent of financing decisions,
  2. Financial markets are perfect,
  3. Financial markets are complete, and
  4. Financial markets provide equal treatment for those seeking financing as well as those who are providing financing.

It is the first assumption, combined with the “… traditional finance principle…” (Hill, 1996) that represents the value of a company is calculated by the net present value of its anticipated future cash flows. The preceding means that there is only one value that can be assigned to that company and that its capital structure does not represent a value added benefit. Thus, the capital structures of ASDA and Wal-Mart have no relationship or bearing on the terms or outcome of the merger.

Chapter 9 – Companies Risk Assessment

Edward Altman (1983) in the 1960’s used ‘Multiple Discriminant Analysis in combination with a set of five financial ratios to result in the ‘Altman Z-Score’. This formula utilizes statistical techniques to predict the probability of failure for a company by eight items from the balance sheet:

  1. Earnings Before Interest & Taxes (EBIT),
  2. Total Assets,
  3. Net Sales,
  4. Market Value of Equity
  5. Total Liabilities
  6. Current Assets
  7. Current Liabilities
  8. Retained Earnings

in combination with ratios and the resultant weight factor as shown in the following Table 7:

Table 7 – Altman Z-Score

(Altman, 1983)

  Ratio Weightage  
A EBIT / Total Assets x.33 -4 to +8.0
B. Net Sales / Total Assets X 0.999 -4 to + 8.0
C Market Value of Equity / Total Liabilities X 0.6 -4 to +8.0
D Working Capital / Total Assets X 1.2 -4 to + 8.0
E Retained Earnings / Total Assets X 1.4 -4 to +8.0

The preceding ratios are then multiplied by the weightage factors indicated with the results added as follows (Altman, 1983): Z-Score = A x 3.3 +B x 0.99 + C x 0.6 + D x 1.2 + E x 1.4 The following are the interpretation of these figures (Z-Score) after the applicati

on of the preceding (Altman, 1983):

  1. Z-Score above 3.0

This indicates that the particular company is ‘safe’, keeping in mind the figures utilized to compile the result.

  1. Z-Score falling between 2.7 and 2.99

A company falling in this category should be noted as being ‘on Alert’ as this is an area where caution needs to be exercised.

  1. Z-Score falling between 1.8 and 2.7

This indicates that there is a high probability that the subject company should go bankrupt in a time frame of two years from the date of the financial figures.

  1. Z-Score that is below 1.8

A Z-Score in this range means that the probability is extremely high of the company going bankrupt. The Z-Score was applied to Wal-Mart for the years 1997 through 2000 with the following results. As the financial figures needed to perform this same correlation for ASDA were not available the Z-Score test was not utilized, however it can be safely stated that Wal-Mart analyzed ASDA for the Z-Score and other factors prior to acquisition and in all probability found nothing negative. A fact that is borne out by the successful post merger results:

  1. Wal-Mart Z-Score for 1997

The following figures were utilized to obtain the Altman Z-Score:

Table 8 – Wal-Mart Z-Score for 1997


Financial Figure

(In Millions)

1. Earnings Before Interest & Taxes (EBIT) 5,695
2. Total Assets 39,604
3. Net Sales 3,056
4. Market Value of Equity 65,895
5. Total Liabilities 20,973
6. Current Assets 17,993
7. Current Liabilities 10,957
8. Retained Earnings 17,143

The resulting Altman Z-Score is 3.26

  1. Wal-Mart Z-Score for 1998

The following figures were utilized to obtain the Altman Z-Score:

Table 9 – Wal-Mart Z-Score for 1998

(Wal-Mart, 2000)


Financial Figure

(In Millions)

1. Earnings Before Interest & Taxes (EBIT) 6,503
2. Total Assets 45,384
3. Net Sales 3,526
4. Market Value of Equity 115,131
5. Total Liabilities 24,134
6. Current Assets 19,352
7. Current Liabilities 14,460
8. Retained Earnings 18,503

The resulting Altman Z-Score is 4.11

  1. Wal-Mart Z-Score for 1999

The following figures were utilized to obtain the Altman Z-Score:

Table 10 – Wal-Mart Z-Score for 1999

(Wal-Mart, 2000)


Financial Figure

21,132(In Millions)

1. Earnings Before Interest & Taxes (EBIT) 8,120
2. Total Assets 49,996
3. Net Sales 4,430
4. Market Value of Equity 261,000
5. Total Liabilities 26,369
6. Current Assets 21,132
7. Current Liabilities 16,762
8. Retained Earnings 21,112

The resulting Altman Z-Score is 7.26

  1. Wal-Mart Z-Score for 2000

The following figures were utilized to obtain the Altman Z-Score:

Table 11 – Wal-Mart Z-Score for 2000

(Wal-Mart, 2000)


Financial Figure

(In Millions)

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The acquisition of ASDA by Wal-Mart. (2017, Jun 26). Retrieved August 11, 2022 , from

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