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Importance of Shareholders in the Company - Tesco Plc

University: UK College of Business and Computing

  • Unit No: 9
  • Level: Undergraduate/College
  • Pages: 14
  • Words: 3500
  • Paper Type: Dissertation
  • Course Code:

    HSP501

  • Country: UK
  • Downloads: 0
Question :

This report is developed for the investors with the help of which they can analyse the performance of the company before investing in the business. For this various task are to be undertaken: 

  • Discount Rates & Capital Structure is determine for the company 
  • Dividend Policy of the company is to be analysed
  • Valuation of the shares is to be done
  • Critical analysis of corporate life cycle is to be done
  • Share price information of the company is analysed 
Answer :
Organization Selected : Tesco Plc

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%

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 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.

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, 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 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

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.

  1. 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.

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 los s 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 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.

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