Corporate Financial Strategy Assignment - Tesco Plc

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%
1

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
2

MODULE TITLE:
CORPORATE FINANCIAL
STRATEGY

Section A
Question: 1
a.
V= D/ K
Where
V= value
D = dividend in next year
K = required rate of return
V= 8/ 7 %
V= 114.3
Thus, with this it can be stated that the price of share of company A is £114.3
b.
The law of one price is one of the theory of economics, according to which after considering the
currency exchange (by expressing the price in similar currency), the price of all the similar
products in different markets should be the same. It is useful in ensuring the similar purchasing
power in the markets across the globe. It is not exactly the absence of arbitrage opportunities
rather a weaker condition of it (de Azevedo, 2017). Therefore, absence of arbitrage opportunity
can be felt with the application of this theoretical concept.
Question 2
It is easy to value A’s debt as zero coupon bond does not pay any interest amount during the life
of the bond and pay a single amount at maturity which is equal to the face value of the bond. The
difference where the bond is issued at discount and repaid at face value. The face value of the
bond is itself the debt of the company (Guduza and Phiri, 2017). But in case of company B’s
bond, it has a coupon attached to it which requires the company to pay fixed amount of coupon
and also at maturity the payment of face value plus interest needs to be made.
Question 3
A
Gain from merger
Cost Amount
Total cash 30000000
Value of company 25000000

5000000
Add-
Marketing cost 400000
Administrative cost 300000
Distribution cost 100000
Total gain 5800000
B
Cost of cash offer= 30000000+2700000= 32700000
C
Cost of share alternative
50 % holding in major
Value of Major = 40000000
50 % of 40000000= 20000000
D
Question 4
A. False
B. True
C. True
D. True
E. True
F. False
G. True
Question 5
Total 10000 ounces
Price= 1250
Spot price= 1100

Module title: Corporate
Financial Strategy

TABLE OF CONTENTS
SECTION A.....................................................................................................................................3
Question 1...................................................................................................................................3
Question 2...................................................................................................................................3
Question 3...................................................................................................................................3
Question 4...................................................................................................................................4
Question 5...................................................................................................................................4
Question 6...................................................................................................................................4
SECTION B.....................................................................................................................................5
Question: 8..................................................................................................................................5
SECTION C....................................................................................................................................9
Question 10.................................................................................................................................9
REFERENCES..............................................................................................................................11

SECTION A
Question 1
A
V= D/ K
Where
V= value
D = dividend in next year
K = required rate of return
V= 8/ 7 %
V= 114.3
B
The law of one price states that all the identical assets and commodities will be having same
prices. This is particularly because of the reason that irrespective of the location or any other
factor is the asset is identical then it will be same priced.
Question 2
The case of company B is complicated because it is not a zero coupon bond. The zero coupon
bond is very easy to be calculated as these are more volatile in comparison to the regular bonds.
Question 3
A
Gain from merger
Cost Amount
Total cash 30000000
Value of company 25000000
5000000
Add-
Marketing cost 400000
Administrative cost 300000
Distribution cost 100000
Total gain 5800000

B
Cost of cash offer= 30000000+2700000= 32700000
C
Cost of share alternative
50 % holding in major
Value of Major = 40000000
50 % of 40000000= 20000000
D
Economies of scale is the one major reason for continuing with the option of merger.
Another reason is that it will add the asset of both the companies and this will provide a better
and effective working and resources.
Question 4
A. False
B. True
C. True
D. True
E. True
F. False
G. True
Question 5
Total 10000 ounces
Price= 1250
Spot price= 1100
Purchase cost= 10000 * 1250 = 12500000
Dragon motors can now buy the contract currently at 1100 that is
10000 * 1100 = 11000000
Profit or loss incurred =
10,000 × ($1,250 − $1,100) = $1,500,000
Question 6
A

Corporate Financial
Strategy

Contents
INTRODUCTION...........................................................................................................................................3
MAIN BODY.................................................................................................................................................3
Dividend policy issue...............................................................................................................................3
Alternative strategies..............................................................................................................................4
International financial risk management policy.......................................................................................5
Alternative strategies..............................................................................................................................6
CONCLUSION...............................................................................................................................................6
REFERENCES................................................................................................................................................8