Capital Structure: Theories and Analysis of Sainsbury and Tesco Plc.

Running head: ADVANCED FINANCIAL DECISION
Advanced Financial Decision
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1ADVANCED FINANCIAL DECISION
Table of Contents
Introduction......................................................................................................................................2
Overview of Capital Structure.........................................................................................................2
Theories of Capital Structure.......................................................................................................2
Empirical Evidence......................................................................................................................6
Analysis of Capital Structure...........................................................................................................7
Conclusion.......................................................................................................................................8
References........................................................................................................................................9
Appendix........................................................................................................................................11

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Introduction
Capital Structure shows the financing structure of a company. It shows how firms on an
overall basis finances the operations and growth of firms from various available sources of funds
for the company. In the context of corporate finance, the capital structure of the companies
shows the various ways by combining different available capital sources like equity, debt and
hybrid securities for the company. Capital Structure is important for financing decision, as it is
important for the company to have an optimal debt and equity mix in the operations and
financing activities of the company. An optimal mix of debt and equity will be necessary for the
company for financing the assets and projects of the company. The report covers the various
aspect of the capital structure maintained by TESCO Company and Sainsbury’s Company.
Overview of Capital Structure
Theories of Capital Structure
The capital structure of the companies plays an important role in the overall financing
decisions of the company. The five important theory that significantly explains the long term
capital sources of financing are:
 Traditional Approach: The traditional theory approach shows that there is an optimal
capital structure in the firm where the companies and firms have an optimal amount of
debt in contrast to the equity level of the company. The traditional theory approach
focuses on the minimum cost of capital approach to attain highest amount of market
value of the firm. The traditional approach assumes that no taxes exists at both the
personal and corporate level (Bhattacharyya and Morrill 2015). The key proposition
made by the traditional theory is that in order to have a minimum cost of capital there

3ADVANCED FINANCIAL DECISION
should be a sound mix of debt and equity which suites the business and financing needs
of the company.
Figure 1: Traditional Theory Approach
(Source: )
Modigliani and Miller (Proposition I): The Proposition I is all about the no-tax net income
approach. The theory states that the Weighted Average Cost of Capital for the company stay the
same at various level of debt financing done by the company. The theory states that the there is
no particular optimal capital structure for a company. The market value of the company depends
on the performance of the company and the expected risk return taken by the company. The
market value of the company and the cost of capital for the company is independent of each
other. The main assumption taken by the theory is that it assumes that is assumes that there will
be no chance of bankruptcy and capital markets are assumed to be perfect (Brusov et al. 2018).