Walmart Case

Walmart’s Use of Interest Rate Swaps

Case Write-Up

1. Describe Wal-Mart’s reliance on debt and their resulting interest rate exposure.

At the turn of the century, Wal-Mart set ambitious growth targets, which are an increase in its domestic market share from 8% to 15% and an increase in its international sales up to 30% of total sales by 2005. To accomplish these goals, first of all, Wal-Mart decided to increase its supercenter stores and to add groceries to shelves. At the same time, Wal-Mart aggressively acquired the overseas discount retail brands to penetrate swiftly into foreign local markets. According to the Exhibit 2 of the case, the number of superstores in U.S. increased from 888 in 2000 to 1,980 in 2005, or 123%, and the number of international stores surged from 1,071 in 2000 to 2,285 I 2005, or 113%.

To meet these goals, Wal-Mart needed the huge capital to invest and accordingly set up the target capital structure as 60% of equity and 40% of debt, the capital structure that would contribute to the accomplishment of the goals and eventually maximizing the value of the firm. However, Wal-Mart’s rather heavy reliance on debt and its entering into interest rate swaps, which switched its fixed rate interest payments to floating rate payments, increased the level of interest rate exposure that is the risk of a loss associated with fluctuations of market interest rates.

2. What is the effect of hedge accounting on Wal-Mart? A conceptual explanation is what is needed.

The purpose of the hedge accounting is to accurately reflect the underlying economics of the hedge. So, the company should match the loss on the hedged item with the derivative’s offsetting gain in the income statement of the same period (Financial Reporting & Analysis 4th Edition, p.640). Wal-Mart’s interest rate swaps were considered fair value hedges since the swaps were entered into to control movements in the fair value of the fixed...