INTRODUCTION TO FINANCE

Introduction to finance



Introduction to Finance

Capital Structure of Tesco Unilever

The two companies selected for to compute WACC are Tesco Plc and Unilever Pl. Tesco is the Retail leader in UK while Unilever Plc is a key player in the fast moving consumer goods (FMCG space). WACC formula which has been used is the weighted average of the cost of equity and debt for the two companies.

WACC= Debt Cost x debt portion + Equity Cost x equity portion in the Capital Structure of the company and Cost of Debt is obtained by dividing the post tax finance costs for the year ending February 28, 2009 for Tesco Plc and year ending December 31, 2009 for Uniliver Plc(as taken from their annual reports), by the average outstanding debt for the year.

Cost of Equity is obtained by applying the Capital Asset Pricing Model (CAPM) which is as follows:

Cost of Equity for a company = Risk free Rate of Return +Beta for the company*(Expected Market Rate of Return-Risk Free Rate of Return)

The 10 year yield on UK Government Treasury Bonds is taken as a proxy for the risk free rate of return. Currently it stands as 4.5% p.a.

Beta is a measure of the systematic risk associated with a company i.e. it indicate the relative movement of the stock price of a particular company in comparison to the benchmark index, which we have taken as FTSE 100. From our computation, we take the Beta for Tesco Plc as 0.79 and for Unilever is 0.84 as derived from Reuters and Google Finance respectively (Reilly, & Brown, 2003, pp. 121).

For our calculation purposes, we can approximate the Expected Market Rate of Return to be the reciprocal of the P/E Ratio of the broader market. The Price/Earnings Ratio for FTSE 100 at the end of Q3 of 2009 was 16.6 times. Thus the Market Rate of Return will be 100/16.6= 6.02%.

Calculation of Cost of Equity Tesco

Book Value of Debt 

12391

48.90%

Book Value of Equity

12938

51.10%

 

 

Risk Free Rate of Return

4.50%

 

Beta

0.79

 

Expected Market Return

6.00%

 

Cost of Equity

5.70%

 

WACC

4.80%

 

Calculation of Weighted Average Cost of Capital (Tesco)

Particulars

Cost (%) [a]

Proportion (%) [b]

[a*b]

Debt

3.80%

48.90%

1.90%

Equity

5.70%

51.10%

2.90%

WACC

4.80%

 

 

Calculation of Cost of Equity Uniliver Plc

 

 

 

Risk Free Rate of Return 

4.50%

 

Beta 

0.84

 

Expected Market Return

6.00%

 

Cost of Equity 

5.80%

 

Book Value of Debt

11205

53.00%

Book Value of Equity 

9948

47.00%



Calculation of Weighted Average Cost of Capital Uniliver Plc

Particulars

Cost (%) [a]

Proportion (%) [b]

[a*b]

Debt

3.60%

53.00%

1.90%

Equity

5.80%

47.00%

2.70%

WACC

4.60%

 

 



Finance of the company

Both the companies have financed their company through the following approaches:

Internal sources of fund

These source of funds are self-generating sources of credit, are obtained in spontaneously.

Share capital (formed as a result of the contribution the company's founders at its creation)

Additional capital (formed as the result of the revaluation of fixed assets of the organization)

Capital reserve (formed by contributions from profit organization for the next unforeseen needs)

This will benefit in terms of following:

Financing through equity has several advantages:

Due to replenishment of the profits of the enterprise increases its financial sustainability;

Formation and use of own funds is stable;

Minimizes the cost of external financing (debt service to creditors);

Simplifies the process of decision making for enterprise development, as sources ...