Corporate Finance: Tesco Plc's Capital Structure Analysis

qwertyuiopasdfghjklzxcvbnmqw
ertyuiopasdfghjklzxcvbnmqwert
yuiopasdfghjklzxcvbnmqwertyui
opasdfghjklzxcvbnmqwertyuiop
asdfghjklzxcvbnmqwertyuiopasd
fghjklzxcvbnmqwertyuiopasdfgh
jklzxcvbnmqwertyuiopasdfghjkl
zxcvbnmqwertyuiopasdfghjklzxc
vbnmqwertyuiopasdfghjklzxcvb
nmqwertyuiopasdfghjklzxcvbnm
qwertyuiopasdfghjklzxcvbnmqw
ertyuiopasdfghjklzxcvbnmqwert
yuiopasdfghjklzxcvbnmqwertyui
opasdfghjklzxcvbnmqwertyuiop
asdfghjklzxcvbnmqwertyuiopasd
fghjklzxcvbnmqwertyuiopasdfgh
jklzxcvbnmrtyuiopasdfghjklzxcv
Corporate Finance
Tesco Plc
4/17/2018
Student Name

1 | P a g e
Table of Contents
Introduction................................................................................................................................2
About capital structure...............................................................................................................2
About MM Approach.................................................................................................................2
Company: Tesco plc...................................................................................................................3
Company’s capital structure.......................................................................................................4
Conclusion..................................................................................................................................6
References..................................................................................................................................8
1 | P a g e

2 | P a g e
Introduction
Franco Modigliani and Merton Miller have given the theory that company's value is
independent of its capital structure. According to them, there will be no change in the
company’s value if its debt and equity funding will change. The company always gives the
same return irrespective of its structural components. The aim of capital structure is to
maximize the wealth of the business and minimize the cost of capital (Cho, El Ghoul,
Guedhami and Suh, 2014). The company will not give the same returns when equity and
debts remain same over the years. Let’s discuss whether the Tesco company value is
dependent on its capital structure or not.
About capital structure
Capital structure is the way how a company collects its funds from the market to purchase
assets and fund its operations. The capital structure can be defined as the ratio of debt and
equity. Debt and equity are equally important in a capital structure as, without any of them,
capital structure is not adequate. An optimal ideal ratio is 2:1 in which there should be equity
and half of equity, debt should be there. Debt comes in the form of debentures, loans, bonds
etc. and equity comprises of retained earnings, preference shares, and equity shares. A capital
structure without debt is considered to be less profitable. The inclusion of debt increases the
earning per share of business as the interest payable on debt fund is deductible in tax
calculation, which leads to rising in share price (Building the Business Case, 2018). A
company without debt in its structure has to pay more tax as interest deduction is not there.
Capital structure helps increase the value of the business, minimizing the cost of capital for
the firm etc.
2 | P a g e

3 | P a g e
About MM Approach
This approach has been devised 40 years ago by the Franco Modigliani and Merton Miller.
According to MM Approach, cost of capital is independent of the capital structure and there
exists no optimal value. According to MM Approach, the value of a firm which uses debt in
its capital structure (leveraged firm) is the same as the value of a firm which uses the only
equity in its capital structure(unleveraged firm) if the operating profits and future aspects are
same. MM proved his theory using arbitrage process. In this process, if the process of
financing and market value of two companies are same then MM model will exist in its
structure (Myers, 2001).
Modigliani and Miller assumed that there will be perfect competition in the market. There is
no transaction cost and taxes paid by the company. Finance through debt funds does not
affect the earnings before interest and tax. MM theory first proposed that the market value of
any business is not dependent on its capital structure and any change in the gearing ratio
cannot affect the company cash flows (Capital Structure Theory – Modigliani and Miller
Approach, 2018). Another MM theory proposed that the rate of return will increase when the
debt-equity ratio will increase. That means both equity and debt increased then only the
returns to a shareholder will increase. Lastly, MM theory proposed that the average cost of
capital will come same when applying in the market in the form of investment irrespective of
the nature and type of funds or securities used. There will be complete separation of the
investment and financing decision.
Company: Tesco Plc
Tesco plc, headquartered in England, is a leading grocery retailer founded in 1929. Tesco is
considered to be the second largest global retailer leader in terms of profits. Tesco performs
3 | P a g e