Executive Summary
The report is on corporate finance, where Tesco Plc is chosen for the analysis as one of the companies found in FTSE 350. The report will be based on the data provided in the annual reports of Tesco Plc. The reports begin with part one by outing the Tesco corporate strategy used for the past three years to maximize the shareholder’s wealth. It also discusses whether the strategy has been consistently used and if it impacted the prices of shares to influence the shareholders’ wealth. Then part two of the report will discuss the pros and cons of using equity and debt financing. Suppose Tesco plans to raise external capital to undertake two projects worth £100m each where the management plans to use the same discounting rate. Then will calculate the cost of capital under the current market conditions. The discussion on the discount rate will follow to evaluate the projects and whether they should use a similar discount rate. The report will demonstrate a thorough knowledge of corporate finance and the everyday use of financial theories. The Tesco plc data from online annual reports and FTSE 350 database will be used as essential keys in analyzing and basis for any discussion and debate on the comprehensive report.
Part 1
Tesco’s company strategy is the overall corporate goal for maximizing shareholder wealth.
Tesco Plc was founded in the United Kingdom and became one of the world’s most successful retailers. The company’s overall business strategy has always been to gain a competitive advantage that it may pay off its investors as much as possible. Corporate performance is measured over time using this technique, and it has proven successful, resulting in increased earnings from firm operations year after year. Tesco’s leadership has followed the same approach for the previous three years to maintain the company’s profitability and provide enough returns to shareholders (Awadari and Kanwal, 2019). In light of the intense competition that has characterized retail markets over the last decade, Tesco’s leadership has reacted to the evolving dynamics and trends in the retail sector to secure a sustainable competitive advantage. Improving the firm’s bottom line and strengthening its financial standing to raise its value to its shareholders has been a top goal.
Tesco Plc has diversified its products and services to increase its market shares and maximize sales. Good performance increases revenue and boosts the overall profitability of the company. That is the strategy that the company has adopted across all its centers in different locations. The maximization of sales through differentiation and offering various products and services to customers is emphasized in Teco Plc. The taste and preference of customers are cantered in Tesco, thus satisfying customers. Therefore, Tesco can get customer loyalty and reach wider potential customers. The firm has invested in improving its online and abroad market marketing processes. By 2019, Tesco had set up and invested heavily in most online services. Extensive marketing has been the backbone of the company’s efforts to maximize sales via social media such as Facebook, Twitter, and WeChat (Crovini et al., 2022). Tesco grew its business and decreased certain delivery services because of economies of scale, which led to customer satisfaction. Tesco has also put much investment expands its operations internationally, where it has established a variety of stores in different countries. That has allowed the company to expand markets and enjoy the benefits of economies of scale. These aspects have kept the company on top of the retail market since it can afford to compete through low prices and still make substantial profits (Flynn, 2020).
The consistency of strategy for the past three years to influence share prices
Tesco PLC has consistently adopted a competitive advantage strategy to increase shareholder value over the last three years. There has been an increase in the value of the company’s stock as a direct outcome of the management’s strategy. The improved financial performance of the firm is largely responsible for this improvement. Shares of the corporation have appreciated as a result of higher earnings per share. Tesco Plc has focused on differentiating its products and services to enhance shareholder value. The previous three years have seen consistent use of this tactic. The firm prioritizes satisfying its clients; thus, it offers a variety of goods and services that may be altered to suit individual preferences. Tesco Finest is an upscale product brand introduced by the retailer to provide consumers with a novel purchasing experience. The company has spent heavily on digital technology, like its online shopping platform, to differentiate its products and enhance the customer experience. Profits at Tesco Plc are up 10.7 percent for the fiscal year 2020-21 due to the company’s efforts to set itself apart from the competition (Mohapatra and MV, 2021).
The differentiation strategy contends that a company’s ability to differentiate itself from competitors is crucial to achieving competitive advantage and sustainable success and has widespread scholarly backing. For instance, Flynn (2020) found that firms that successfully differentiated their offerings outperformed competitors in terms of market value and stock returns. It was true in every sector. Since the turn of the decade, all of Tesco Plc’s business decisions have been guided by a strategy of using the company’s competitive advantage to generate the greatest possible return for the company’s shareholders. The company’s priority is to distinguish itself from the competition to continue to succeed in the market and increase its profit margins (Flynn, 2020). Sales, profits, and stock prices have all increased due to this strategy being implemented throughout the term.
Moreover, there is strong support for the strategy from the research that has been undertaken, which shows that setting oneself apart from the competition is crucial to achieving both short-term and long-term success. Tesco has also prioritized increasing consumer loyalty. The company has invested heavily in initiatives like customer loyalty programs, consumer segmentation, and targeted marketing to reach this objective. Tesco’s ability to better tailor its product and service offerings to meet its consumers’ needs is mainly attributable to the insights gained via these initiatives (Moura, 2021). The result has been increased repeat business and satisfied customers, boosting the company’s growth and bottom line.
Lastly, Tesco has made innovation a central strategy for maintaining a competitive edge. The business has spent money on R&D to create and enhance current goods and services and create new ones (Puertas et al., 2023). The company can keep up with the ever-changing industry and seize new possibilities. The consistent pursuit of competitive advantage by Tesco over the last three years has been a significant factor in the company’s expansion and success. The firm has increased its share price and maintained its status as a market leader thanks to this approach. The firm’s share price has climbed by 38.5% during the last three years, from £2.60 in 2016 to £3.60 in 2019 (Flynn, 2020). As a result, it seems that Tesco’s approach to cost leadership, customer loyalty, and innovation has successfully maximized shareholder value.
Part 2
Pros and Cons of Equity and Debt Financing
A company’s liquidity, which it may raise via equity and debt financing, can be used to finance investments and new initiatives. A company may choose between equity investors and debt investors regarding long-term financing. Debt financing is advantageous since a company’s interest may be deducted from its taxable income. Risks associated with equity and loan capital might reduce the company’s profitability (Puertas et al., 2023). Overextending a company’s credit increases the risk of default, which may alter the value of its shares. Equity financing involves raising capital via issuing and selling stock to finance ongoing business activities rather than getting capital from third parties, such as loans from a bank, issuing bonds, or taking out loans. However, when used by companies to raise funds for projects, equity financing has pros and cons. Using debt financing may have positive and negative effects, as discussed later after equity financing.
The notable pros of equity financing involve having No repayment obligation since Equity financing does not require the company to make any repayment obligations to the investors, as opposed to the case with debt financing, which demands the company to make regular repayments to service the debt. It gives the company greater financial flexibility and freedom from debt servicing obligations. Ownership control is another pros that equity financing does not dilute the ownership control of the existing shareholders. It allows the shareholders to control the company’s operations and decisions. Tax advantages are another pros enjoyed in equity financing is usually tax-deductible, and the investors may not have to pay taxes on their dividend income hence maximizing their wealth (Crovini et al., 2022).
The cons of equity financing can include the dilution of ownership because the other new investors will have a stake in the company’s overall ownership, causing the existing owners’ shares to be diluted. That happens since equity financing can dilute the ownership of existing shareholders, as the new shareholders will own a portion of the company. There is also a loss of control as the new investors will have a say in the company. The investors in the company may have influence and participate in the operations and decisions making of the organization, which can lead to a loss of control by the existing shareholders. The other cons are the high cost of Equity financing since it is more expensive than debt financing, as the investors in the company expect a higher return on their investment (Mohapatra and MV, 2021).
Pros of Debt Financing involve the lower cost of acquiring the capital. Debt financing is less expensive than equity financing since the loan’s interest and repayment are lower than the company paying the investors their returns. Tax deductions are another pros in debt financing as the interest payments on the loan are usually tax-deductible, which gives the company a tax advantage. The other pros is the repayment obligations which can make the company focused and try to repay within a short period. Debt financing requires the company to make repayment obligations to the lender, which can provide the company with a sense of discipline and responsibility to the company (Moura, 2021).
Cons of Debt Financing involve the risk of default when the company is in financial distress and unable to repay the loan. The failure to pay the third parties can lead to legal action being taken against the company, which will risk the company’s assets of the company and the wealth of stakeholders. Another cons is the loss of control where the company has a lot of debt financing since it is claimed over its assets. The high debts may limit the owners from making independent decisions (Mohapatra and MV, 2021). The leaders may make or influence the company’s major decisions, leading to a loss of control by the existing shareholders. Increase in debt: Debt financing increases the debt burden of the company, which makes it difficult for the company to make further additional financing hence limiting its growth.
Calculation of Cost of Capital
Weighted average cost of capital (WACC) modeling combined with current market circumstances may be used to approximate the cost of external capital. Weighted Average Cost of Equity and Debt for the Company (WACC) is the sum of an organization’s interest and principal payments on its stock and debt. The company’s capital structure affects which weights should be applied to the WACC calculation (Moura, 2021. By dividing the overall cost by the sum of the component weights, we can get the cost per unit. Along with the risk-free rate and the risk premium, the needed rate of return on equity investments is used to compute the cost of equity (Re). The interest rate on a loan is adjusted downward by the tax rate to get at the cost of debt. The “Rd” sign represents accrued interest (Moura, 2021).
Taking out a loan now and using this calculation will give a better idea of how much one will have to pay back:
Using the formula: WACC = (Weight of Debt x Cost of Debt) + (Weight of equity x cost of equity)
In present market circumstances, the external cost of capital may be computed as follows, assuming a tax rate of 20%, a risk-free rate of 0.5%, an interest rate on the debt of 6%, and a risk premium of 4% (Mohapatra and MV, 2021).
WACC = (0.5 x (0.06 – 0.2)) +(0.5 x 0.05)
WACC = 0.02 +0.025
WACC = 0.045 = 4.5%
Discount Rate for the Two Projects
When weighing the two projects, the company’s discount rate should be based on the required rate of return from investors and the risk associated with each project. The company could provide more significant discounts for higher-risk initiatives and smaller discounts for lower-risk ventures. The company should use different discount rates for each project since each has risks. The firm ought to adopt a discount rate equal to the cost of external capital under current market conditions to compare the two projects. The cost of capital is the opportunity cost of investing in the ventures at hand, given that the money might have been used for other, equally hazardous projects (Mohapatra and MV, 2021). There is no need to use a different discount rate for each project since the cost of capital is the same. The company may use different discount rates for the two projects if it considers that they have considerably different risk profiles. For example, a company may use a higher discount rate for a riskier project.
References
Awadari, A.C. and Kanwal, S., 2019. Employee participation in organizational change: A case of Tesco PLC. International Journal of Financial, Accounting, and Management, 1(2), pp.91-99.
Brunner-Kirchmair, T.M. and Wiener, M., 2019. Knowledge is power–conceptualizing collaborative financial risk assessment. The Journal of Risk Finance, 20(3), pp.226-248.
Crovini, C., Schaper, S. and Simoni, L., 2022. Dynamic accountability and the role of risk reporting during a global pandemic. Accounting, Auditing & Accountability Journal, 35(1), pp.169-185.
Flynn, A., 2020. Determinants of corporate compliance with modern slavery reporting. Supply Chain Management: An International Journal, 25(1), pp.1-16.
Mayer, C., 2020. Shareholders versus Stakeholderism-A Misconceived Contradiction: A Comment on” The Illusory Promise of Stakeholder Governance,” by Lucian Bebchuk and Roberto Tallarita. Cornell L. Rev., 106, p.1859.
Mohapatra, P. and MV, N.K., 2021. Accounting Scandal at Tesco. IUP Journal of Accounting Research & Audit Practices, 20(4).
Moura, M.B.L.D., 2021. Equity Research in Food & Retail Industry-TESCO PLC (Doctoral dissertation, Instituto Superior de Economia e Gestão).
Puertas, A.M., Clara-Rahola, J., Sánchez-Granero, M.A., de las Nieves, F.J. and Trinidad-Segovia, J.E., 2023. A new look at financial markets efficiency from linear response theory. Finance Research Letters, 51, p.103455.
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