Tesco Financial Analysis

1. Calculating WACC for TESCO using Dividend Growth Model (DGM) and Capital Asset Pricing Model (CAPM). WACC figures are to be used as a basis for the discount rate in capital investing decisions. Therefore the comments on WACC figures’ relevance and usefulness are provided.

APPENDIX 1.

Calculating WACC using DGM and CAPM methods.

1. DGM. Calculating Cost of Equity (Ke) using the dividend growth model.

Equation:

Ke= Do (1+g)/MV +g

Where,

Do – last dividend paid

g – trend rate of growth

MV – market value

Assumptions:

* Dividend growth is extrapolated in the future

* Sustainable dividend growth;

* Stable share price;

* All shareholders have the same expectations on dividends to be paid;

* No tax adjustment;

Do = 14.46p as stated in the company’s 2011 annual report. (Pic.1)

g = 10%. The trend rate of growth was calculated using the data of 5 years period as stated in TESCO financial statement (Pic.1), i.e.

9.64p(1+g)4 = 1.0066

MV = 316.70p, as stated at the company’s website, dated: 27.02.2012.

Pic.1. Dividend per share.

Source: TESCO annual report 2011. Financial statement, p. 146

Ke= 14.46 (1+0.10)/316.20 + 0.10 = 15.906/316.70 + 0.10 = 0.150 = 15%

Ke = 15%

2. CAPM. Calculating Ke using capital asset pricing model.

Equation:

Ke= Rf + B(Rm Rf)

Where,

Rf – risk-free rate

B – Beta coefficient (systematic risk of company’s shares)

Rm – market return rate

Assumptions:

* Investors’ expectations on return rate are similar;

* No tax adjustment;

* For risk-free rate for 10-years UK Government Bonds are considered as per Bloomberg.com data. (Pic.2);

* Market return rate.

Pic.2. UK Government Bonds

Source: http://www.bloomberg.com/markets/rates-bonds/government-bonds/uk/ [Accessed: 27.02.2012]

Rf = 3.750%

B = 0.7026

Rm =

3. Calculating WACC.

Equation:

WACC (DGM) = (Ke*Ve + Kd*Vd) / (Ve+Vd)

Where,

Ke – cost of equity = 15%

Ve – value of equity =2 548 316 444 736.4...