Corporate Finance and Investment Analysis

This assignment involves a detailed examination of corporate finance strategies that aim to maximize shareholder value. The document reviews various studies and research papers on the topic, including works by Ajello, Bucă and Vermeulen, Busch et al., Frésard and Valta, Kosinova et al., Mellahi et al., Qiu et al., Rugman and Verbeke, Shen and Lin, Trumpp and Guenther, and Wang et al. It also explores the relationship between corporate investment and bank-dependent borrowers during the recent financial crisis, sustainable development and financial markets, security analysis for investment and corporate finance, how corporate investment responds to increased entry threat, and the impact of environmental and social disclosures on corporate financial performance.

Corporate Financial Strategy

TABLE OF CONTENTS
INTRODUCTION...........................................................................................................................1
MAIN BODY...................................................................................................................................1
A) Discount rates and Capital structure..................................................................................1
1. Computing Cost of Equity, Weighted Average Cost of Capital (WACC) and Cost of Debt
................................................................................................................................................1
2. Assessing capital structure of the organisation..................................................................2
B) Dividend Policy.................................................................................................................4
1. Dividends paid in last five years........................................................................................4
2. Critically evaluating whether dividend pay-outs are affordable........................................5
3. Consistency with stated dividend policy............................................................................6
C) Valuation...........................................................................................................................7
Value of equity shares with both methods.............................................................................7
D) Discussing whether company is in Corporate Life Cycle and computing ratios..............8
E) Calculation of shareholder value performance of organisation.........................................9
CONCLUSION................................................................................................................................9
REFERENCES..............................................................................................................................11

INTRODUCTION
Corporate financial strategy is required to be implemented for attaining good financial
condition. Present report deals with importance of shareholders’ in the company and Tesco Plc
has been chosen which is engaged in retail sector in UK. Cost of equity, Cost of debt and WACC
is calculated for last five years. Moreover, capital structure of company is also analysed whether
it is under leveraged or over leveraged firm. Dividend pay-out ratio is computed for five years
whether adequate dividends are paid by the company or not. Furthermore, valuation of equity
shares have been attained through static multiple and other technique as well. Corporate Life
Cycle is explained along with various financial ratios. Furthermore, shareholder value
performance is also calculated for last years. Thus, it can be said that all these information help
investors to assess whether investment should be made in company or not.
MAIN BODY
A) Discount rates and Capital structure
1. Computing Cost of Equity, Weighted Average Cost of Capital (WACC) and Cost of Debt
Particulars 2013 2014 2015 2016 2017
(in
millions)
Market cap (E) 32017.85 44769.94 30813.2 20543 19047.5
Beta value 0.31 0.5 0.57 0.55 0.45
Risk Free Rate (RFR) 1.508 1.508 1.508 1.508 1.508
(10 year government maturity bonds)
Risk Premium 6 6 6 6 6
Cost of equity (Ke) 3.368 4.508 4.928 4.808 4.208
Cost of debt (Kd)
Interest expenditure 1266 915.56 958.59 912.86 787.5
Debt (Book Value) 26000 37350.08 36399.1 30737 25079.1
Cost of debt (Kd) 4.87% 2.45% 2.63% 2.97% 3.14%
Tax rate applicable 41.78% 41.78% 41.78% 41.78% 41.78%
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Debt (Weights)
formula
D / (E + D) 0.448137944 0.454823 0.54155 0.5994 0.56834
Equity (Weights)
E / (E + D) 0.551862056 0.545177 0.45845 0.4006 0.43166
WACC
(We*Ke + Wd*Kd*1-Tax
rate) 1.46 2.05 1.86 1.53 1.42
2. Assessing capital structure of the organisation
Particulars Formula 2013 2014 2015 2016 2017
Solvency ratios
Financial
leverage
Average assets /
Average equity 3.01 3.4 6.25 5.09 7.12
The capital structure plays important role in the company to meet financial needs in the
best possible manner. It is required that firm should have proper mix of both finances such as
debt and equity resources in effective way. This is essential because more debt increases burden
of repaying principal amount which negatively impacts solvency position of company. On the
other hand, if equity is used in excess, then expectations of shareholders’ increases as they
demand more dividends. This impacts market value of shares. Thus, it can be said that adequate
mix of debt and equity is quite beneficial for the company to effectively meet its operational
requirements in effectual way (Damodaran, 2016).
Moreover, using debt finance in balanced way provides control to the organisation in
financing its activities. Usage of this source also imparts deduction in tax liability as amount paid
by organisation is tax deductible on the interest paid in instalments. On the other hand, equity
financing should be used in adequate manner so that maximum benefit may be availed by the
business in the best possible way. Advantage of equity is that business has no liability to repay
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any debt unlike other financing option. This is because shareholders’ money is utilised by
organisation and it has to pay dividends on the same. However, if firm garners no profits in a
particular year, then shareholders’ are not required to pay dividends. It is one of the main merit
of using equity financing. Thus, optimal mix of debt and equity in the capital structure meets
operational requirements of firm in a better way.
Tesco Plc is one of the biggest retail company headquartered in UK and generating
revenue in effectual manner by satisfying customers quite easily (Wang, Dou and Jia, 2016). It is
producing profits in past financial years which can be reflected from the financial statements of
the company. In relation to this, capital structure of Tesco Plc may be analysed as it forms mix of
both debt and equity for financing its activities. Starting from cost of equity in recent years. It
can be analysed that equity was 3.36 % in 2013 4.508 % in 2014 year and the same increased to
4.928 % in 2015. While, cost f equity in 2016 was 4.808 %. This implies that this source of
financing had been lowered down in past years. On the other hand, the figure was 4.208 % in the
2017 year. Thus, it can be analysed that cost of equity has reduced in past periods.
Cost of debt is also taken out for Tesco Plc. It was 4.87 % in 2013 and 2.45 % in 2014
financial year and in next year, it was 2.63 % which implies that cost of debt had been reduced
by the company. Moreover, debt again decreased to 2.97 % in 2016 and increased to 3.14 % in
2017 year. Company is effectively using debt as it is continuously increasing the same in its
capital structure. This implies that company has started using debt in recent years. This means
that firm is relying on cheaper source of finance. On the other hand, use of equity is more as
compared to debt by the organisation. It clearly shows that though debt is used less but it can be
seen that company is increasing the usage of debt as the same has immense benefits if used in
balanced way (Rugman and Verbeke, 2017).
In relation to above analysis, Tesco Plc may be regarded as under leveraged organisation
due to fact that more equity is used instead of debt for effectively financing day-to-day activities
in the best possible manner. It is required by the firm that it should use both sources of finance in
balanced way in order to extract benefits of each with much ease. Furthermore, company should
rely equally on both as more usage of equity affects market value of shares while using debt in
excess leads to increase burden of repayment to make the same to creditors and other parties
from whom debt is taken. Thus, appropriate mix of equity and debt is always beneficial for the
firm to financing tasks in a better way.
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On the other hand, from the cost of debt and equity, WACC (Weighted Average Cost of
Capital) is calculated. The same is computed by assigning weights to both cost of finance and as
such, results are extracted with much ease. Value of WACC was 1.46 % in 2013 and further
increase 2.05 % in 2014, 1.86 in next year and 1.53 in 2016. While these figures were further
reduced to 1.42 in 2017 (Qiu, Shaukat and Tharyan, 2016). This implies that firm had been
successful in lowering down WACC which shows that value of Tesco Plc is maximising as
decreasing value of WACC leads to enhancement of organisation in the best possible manner.
On the other hand, financial leverage is computed which is increased up to a high extent in recent
years. This is evident from the fact that ratio was 3.01 in 2013 and maximised to 7.12 in 2017.
Thus, it shows that company has more of total assets as compared to total equity. It means that
Tesco Plc has adequate amount of assets which can be used to pay-off liabilities. Furthermore,
shareholders will be benefited as firm is earning profits.
B) Dividend Policy
1. Dividends paid in last five years
The dividends should be paid by company in order to provide greater returns to
shareholders in the best possible manner. This is required so that enough of investment may be
garnered by the firm with much ease. Moreover, more shareholders would be effectively
attracted towards company and as such, firm may be able to produce profits by financing
operational activities in effectual way. This is essential for company so that more of the
investment may be made by the investors in effective manner.
Moreover, it can be analysed that Tesco Plc is providing adequate dividends to its owners
from which profits are garnered by the firm. In simple words, dividends are regularly paid by
organisation. This is evident from the fact that dividend pay-out ratio was 38.4 in 2013 provided
to shareholders in the best possible way (Ajello, 2016). This was further increased to 106.1 in
2014 financial year which is remarkable as firm had earned good quantum of profits and as such,
more dividends were paid in year. While, in 2015, ratio was maximised up to a high extent. This
means that company is imparting good dividends to shareholders.
On the other hand, in 2016 and 2017, firm had not paid part of profits to shareholders as
the ratio was 0 in both years. This is evident from the fact that company is unable to make profits
and as such, shareholders are disheartened as because of absence of income, dividends are not
paid by company. The dividends paid by the company in the past two years are 0 and as such, it
is required that company should perform well so that profits may be attained by it. Moreover,
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Tesco Plc is required to initiate control upon its expenses and as such, profits may be achieved
by the company in the best possible manner. Moreover, organisation is needed to provide good
dividends and this can be accomplished when company garners profits with much ease. Thus,
organisation may effectively achieve good profits and adequate dividends could be paid to
shareholders.
2. Critically evaluating whether dividend pay-outs are affordable
The dividends should be paid in adequate manner so that company may be able to finance
its activities in the best possible way (Kosinova, Tolstel, Sazonov and Vaysbeyn, 2016). This is
essential because through more investments, organisation may be able to perform well and as
such, profits can be garnered in effective way. The company is required to pay desired dividends
to shareholders so that it may be able to garner investments and as such, profits can be produced
by utilising money in optimum way. Moreover, it is required that company should provide
dividends as per the profits earned by it. This is important as without having adequate net
income, it cannot pay dividends to shareholders.
On the other hand, Tesco Plc has generated huge profits in past years. This is cleared
from the financials of company that dividend pay-out ratio had been good over the periods. The
ratio was just 38.4 in 2013 which increased to 135.1 in 2015 financial year. It shows that Tesco
Plc had been providing desired dividends to its shareholders in the best possible manner.
However, the scenario changed after 2015 as company is unable to provide dividends to
shareholders. In 2016 and 2017, pay-out ratio was nil and main reason behind such situation is
that firm is unable to garner profits. This has worsen the position of it as shareholders are not
paid dividends and as a result, company should perform well so that profits may be produced and
as such, from the profits, dividends can be paid with much ease (Mellahi, Frynas, Sun and
Siegel, 2016).
The dividend pay-outs are affordable as company had earned good income and as such,
higher dividends were paid to company’s owners. However, it has not paid dividends in couple
of years such as 2016 and 2017. This is done with a view that sufficient profits were not attained
and as such, company was unable to provide part of shareholders. Thus, it is required that
company should initiate control upon its expenses so that profits may be accomplished in a better
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way. This would provide greater returns to shareholders as more of revenue will be generated by
the firm.
3. Consistency with stated dividend policy
The dividends paid by Tesco Plc was good in previous years but it had decreased in past
couple of years. It is required that company should generate enough of profits and as such,
adequate dividends may be provided to the shareholders with much ease. Furthermore, high
investments could be availed by firm only when desired returns are provided to shareholders.
This is important as investors seeks for higher returns on the investment made by them. Thus,
Tesco Plc should consistently impart dividends to investors in order to garner more investments
to them in the best possible manner. This would also help company to attract more investors and
as such, more funds would be available to organisation to finance activities quite effectually
(Busch, Bauer and Orlitzky, 2016).
The dividends should be paid in adequate manner in order to attain faith and loyalty of
investors in effectual way. Tesco Plc had imparted good quantum of dividends to shareholders.
This can be analysed from the dividend pay-out ratio as it was 38.1 in 2013 and maximised to
138.1 in 2015 financial year. This implies that dividends were consistently increased by the
company and investors were benefited as well. But afterwards, due to low profits generated by
firm, no dividends were paid. Thus, it is required that company should follow consistency policy
of dividends and shareholders may be benefited quite effectively.
In relation to this, economic theory may be explained such as Walter’s Model. This
theory is quite relevant in the aspect of dividend policy followed by the firm. The model states
that value of firm is affected by policy implemented by it (Bucă and Vermeulen, 2017). This
clearly means that good dividend related policy must be followed so that value may be
maximised in the best possible manner. The objective wealth maximisation of shareholders can
be effectively achieved by company. This model has assumptions such as cost of capital remains
constant. Moreover, IRR is stable as well. Debt financing is used and equity is neglected.
However, these assumptions are rare phenomenon in the business.
C) Valuation
Value of equity shares with both methods
1. Valuing through static multiples
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Price Earnings ratio
Formula 2013 2014 2015 2016 2017
Market price of shares / EPS (Earnings
Per Share) 26 17.6 0 80 37.6
The Price Earnings (P/E) ratio is being calculated for the past five years of Tesco Plc. This
will provide clarity about the value of equity shares of company in recent periods in the best
possible manner. It can be interpreted that P/E ratio clearly shows value of company with
regards to current price of share and is divided by earnings made by organisation on its per
share (Trumpp and Guenther, 2017). This maximises company’s wealth as higher P/E ratios
is always preferable for the firm. It can be analysed that Tesco Plc had 26 ratio in 2013 which
was decreased in further year as it came down to 17.6. This means that company’s value of
equity share was reduced in 2014 year. While, in next year, ratio was zero as firm’s
performance was not good which led to such downfall. On the other hand, P/E ratio increased
up to a high extent as it reached to 80 in 2016 financial year which implies that Tesco Plc had
implemented well-structured strategies which had produced better results. While, in 2017m,
it again came down to 37.6 and as such, value of equity shares was minimised.
2. Valuation technique
ROCE 2013 2014 2015 2016 2017
Formula 6.29% 7.85% -26.13% 0.67% 0.55%
EBIT / Capital
employed 1960 2259 -6376 162 145
31144 28765 24404 24190 26448
ROCE (Return on Capital Employed) is adequate way to attain value of equity shares in the
best possible manner. It means that profitability aspect of the organisation can be attained as
ROCE measures return on equity by reflecting capital employed in the capital structure of
company in effectual way. Capital employed is calculated by the subtracting current
liabilities from total assets of the company. It can be analysed that ROCE of Tesco Plc in
2013 was 6.29 % and it was further increased to 7.85 %. This shows that firm was able to
utilise shareholders’ investment and as such, ratio was increased up to a high extent (Shen
and Lin, 2016). Furthermore, in 2015, it became negative because of low profits and
investment was not effectively used by the firm. The ratio became positive in 2016 as it was
0.67 %. It further reduced to 0.55 % in 2017. Thus, it is required that firm should increase its
ROCE in future and as such, performance can be increased as well in effectual manner.
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D) Discussing whether company is in Corporate Life Cycle and computing ratios
Corporate Life Cycle is useful in assessing performance of company in order to determine
whether business is able to implement effective financial strategies or not. It means that
life cycle of company from when it is created or started and ends when it is closed.
Corporate Social Strategy given by Ruth Bender clarifies regarding financial condition of
the company in the best possible manner.
Calculation of ratios
Particulars Formula 2013 2014 2015 2016 2017
Gross profit
ratio Gross profit / sales * 100 6.6 6.3 -3.9 5.3 5.2
Net profit
ratio Net profit / sales * 100 0.19 1.53 -9.22 0.25 -0.07
Debt to
Equity ratio Debt / Equity 0.6 0.63 1.51 1.24 1.47
Free cash
flow
Operating cash flow –
Capital expenditures -150 304 -1834 1088 615
Dividend
payout ratio Dividends / Net profit 38.4 106.1 135.1 0 0
Financial ratios of Tesco Plc are calculated for past five years from 2013 to 2017. It can
be analysed that performance has been decreased in recent periods. Gross profit ratio in 2013
was 6.6 % and it decreased to 6.3 % in next year. On the other hand, ratio became negative in
2015 as it was -3.9 %. It implies that company was unable to control upon operational expenses
and as such, gross profit has decreased up too much extent. While, it had reduced expenditures in
2016 as profit was attained by 5.3 %. Moreover, slight decrease was observed in 2017. This
means that Tesco Plc is able to reduce its expenses and in future, profit will increase (Frésard and
Valta, 2016).
Net profit margin was 0.19 in 2013 which was increased to 1.53 in 2014. This implies
that company is able to generate profits with much ease. However, in 2015, net profit became
negative which shows that loss had been incurred by the organisation. Furthermore, it is required
that firm should initiate control over unnecessary expenditures. In 2016, profit was 0.25 and in
next year, it again became negative. This shows that profitability position of company is not
good. Debt equity ratio is also computed of the company which shows that it was 0.6 in 2013.
While, it was 0.63 in next year and slight increase was noticed.
However, debt to equity ratio was maximised in 2015, 2016 and 2017 up to a high extent.
This is not ideal for the company as it shows that more of debt is financed in the capital structure
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as compared to equity. The ideal ratio as recommended by market analysts is less than 0.4. This
means that debt is highly used by the company and as such, debt paying capacity will be
increased. It implies clearly that organisation has to repay debt. On the other hand, Free cash
flow available to Tesco Plc was -150 in 2013. This means that it had no cash flows to pay
amount to creditors. Moreover, ratio became positive in 2014 as the same was 304. The situation
was worsened in 2015 as cash flow ratio was -1834 which signifies clearly that firm had negative
cash flows after spending on liabilities. However, ratio effectively improved as it was 1088 in
2016. This shows firm had money left over after paying out for expenses to be utilised in
expanding operations or for making investment. Dividend pay-out ratio as discussed was good
till 2015 and then it was zero in subsequent years. Thus, it is required that Tesco Plc should
improve upon its financial health.
E) Calculation of shareholder value performance of organisation
Shareholder Value
Creation 2013 2014 2015 2016 2017
Formula 122.54 971.95 -5742.86 214.47 86.58
Net profit – Cost of
capital 124 974 -5741 216 88
1.46 2.05 1.86 1.53 1.42
The shareholder value performance is effective way to provide clarity whether firm is
earning well or not (Definition of 'Shareholder Value'. 2018). Company is required to enhance
value of shareholders so that more investment can be attained. It can be analysed that in 2013,
shareholder value was 122.54 which increased to 974 as more earnings were made by it. While,
in 2015, expenses were incurred more and earnings became negative. Afterwards, it was 214.47
in next year and decreased to 86.58 in 2017.
CONCLUSION
Hereby it can be concluded that investors should be provided with greater returns so that
more investment may be made by them benefiting organisation up to a high extent. WACC
provides clarity that whether company should lower debt or equity to maximise value in the
market. Furthermore, there should be adequate mix of both sources of finance so that advantage
may be extracted by using each of them. Dividends should be paid by company in adequate
quantum which maximises trust of shareholders and as such, more investment can be attained by
firm.
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REFERENCES
Books and Journals
Ajello, A., 2016. Financial intermediation, investment dynamics, and business cycle
fluctuations. American Economic Review. 106(8). pp.2256-2303.
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Bucă, A. and Vermeulen, P., 2017. Corporate investment and bank-dependent borrowers during
the recent financial crisis. Journal of Banking & Finance. 78. pp.164-180.
Busch, T., Bauer, R. and Orlitzky, M., 2016. Sustainable development and financial markets: Old
paths and new avenues. Business & Society. 55(3). pp.303-329.
Damodaran, A., 2016. Damodaran on valuation: security analysis for investment and corporate
finance (Vol. 324). John Wiley & Sons.
Frésard, L. and Valta, P., 2016. How does corporate investment respond to increased entry
threat?. The Review of Corporate Finance Studies. 5(1). pp.1-35.
Kosinova, N. N., Tolstel, M. S., Sazonov, S. P. and Vaysbeyn, K. D., 2016. Development of
Methodological Approach to Enterprise's Financial Strategy Based on Comprehensive
Evaluation of Its Strategic Potential. European Research Studies. 19(2). p.21.
Mellahi, K., Frynas, J. G., Sun, P. and Siegel, D., 2016. A review of the nonmarket strategy
literature: Toward a multi-theoretical integration. Journal of Management. 42(1). pp.143-
173.
Qiu, Y., Shaukat, A. and Tharyan, R., 2016. Environmental and social disclosures: Link with
corporate financial performance. The British Accounting Review. 48(1). pp.102-116.
Rugman, A. and Verbeke, A., 2017. Global corporate strategy and trade policy. Routledge.
Shen, C. H. and Lin, C. Y., 2016. Political connections, financial constraints, and corporate
investment. Review of Quantitative Finance and Accounting. 47(2). pp.343-368.
Trumpp, C. and Guenther, T., 2017. Too Little or too much? Exploring U‐shaped Relationships
between Corporate Environmental Performance and Corporate Financial
Performance. Business Strategy and the Environment. 26(1). pp.49-68.
Wang, Q., Dou, J. and Jia, S., 2016. A meta-analytic review of corporate social responsibility
and corporate financial performance: The moderating effect of contextual factors. Business
& Society. 55(8). pp.1083-1121.
Online
Definition of 'Shareholder Value', 2018 [Online] Available Through:
<https://economictimes.indiatimes.com/definition/shareholder-value>
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