Brighton University

Thomas Newcombe-13810707
Finance and Investment
Finance and Risk Management-FN282

Finance and Risk Management

Coursework
Contents
1.
2.
3.
4.

Recent financial performance analysis

Share Valuations
Equity Valuation Methodology Analysis
References

1. Recent Financial Performance Analysis

To analyse the financial performance of Tesco, one must look at various ratios. The first ratio to
consider is the EBITDA. EBITDA is earnings before interest, taxes, depreciation and amortization. It
can be used to calculate the ability of companies to pay back interest on financed deals. EBITDA is
found with the following equation;
EBITDA= Revenue-Expenses (excluding taxes, interest, depreciation and amortization)
Yahoo finances (2015) most recent data reports that Tescos EBITDA is 3.42 bn. This is a much higher
figure compared to its rivals Sainsburys, whose EBITDA is 1.39 bn. These figures show that Tesco is
performing well financially compared to its rivals.
The second ratio to look at when analysing the financial performance is the current ratio. It is
calculated using the following equation;
Current Ratio= Current Assets/Current Liabilities
The current ratio of Tesco is 0.69 according to Yahoo finances (2015) most recent data. This figure as
it is below one could cause a problem for the firm to meet its short term obligations. However this
could not be the case as Tesco is a business able to operate with a low current ratio as the inventory
has a fast turnover due to the amount of sales made every day. The figure is also not over one,
meaning that there is a suitable amount of re investment.

A third ratio that can be used to analyse the current financial performance of Tesco is the Net Profit
Margin. This ratio can be calculated with the following formula;
Net Profit Margin= Profit before interest and tax X 100
Revenue or Turnover
Yahoo Finance (2015) show the NPM of Tesco to be 0.26%. This is a good figure and indicates that
there is good managerial ability and good use of turning sales into profit.
Overall these ratios show that the recent financial performance of Tesco is adequate and currently
suitable for an investor to consider bidding for at the correct price.

2. Valuation
To find what to offer for the company, one must look at valuations. The first of these valuations is
the constant dividend growth valuation model. This model is found using the following formulas.
Market Value= Dividend payment (1+growth rate)
Cost of equity- growth rate
The dividend growth rate can be found using the following formula;
Growth rate= Number of years of growth (last dividend paid/first dividend paid)-1
The cost of equity can be found using the following formula;
Cost of equity= Dividends per share (for next year) + Growth rate of dividends
Current market value of stock
This model has various assumptions. These assumptions are, that there is constant dividend growth
and it always rises, that there is a constant growth rate and the dividend will always grow at this
rate, and that the growth rate is a correct figure as it is calculated using historical data.
The market valuation using the constant dividend growth model for Tesco Plc is: 155.05GBP
A second model to look at to find a value to offer for the company is the Price Earnings Ratio (PER).
PER is found using the following formula.
PER= Share Price/ EPS (earning per share)
This models assumptions are; that the EPS is an accurate figure, and that the other companies EPSs
are accurate figures and comparable.
The market valuation using the PER model for Tesco Plc is: 18.48GBP
This figure can be compared to the industry is lower with the industry PER at 22.79GBP. This
highlights that an investor should not be prepared to offer the share price for the company as the
PER is low and cannot guarantee a higher return compared to other firms within the industry.
A third model to consider is the Net Current Assets model (NAV). This model assumes that the
balance sheet intends to reflect the value of the business.
The market valuation using the NAV model for Tesco Plc is: 14722MGBP

This shows the minimum an investor should offer for the company as it is ultimately the companys
worth.
Overall, when considering what to offer for the company, an investor should consider these three
models. A suitable suggestion as a starting bid to offer the company would be 175.00GBP per share.
This is higher than the constant dividend growth model meaning that there would be a return on the
investment through dividends. This also takes into account the PER model as it is low the offer
should be lower than the market price of the share at 203.25 GBP.

3. Equity Valuation Methodology Analysis

One of the valuation models used above is the PER model. This model is seen as the most common
for valuing a share, as highlighted by Arnold (2013). Bierman (2002) writes that theoretically, one
advantage of PER is that it can be used very easily to find a firms value and growth while comparing
it with other firms. Anderson and Brooks (2006) suggest that this is the cause of its popularity.
However Arnold (2013) writes how this could be disadvantageous and comparisons may not always
be accurate. This is due to the theory that a high PER does not necessarily mean that there is high
growth, just that it has been higher than previously.
In terms of practicality, PER is very relevant as a valuation model. Anderson and Brooks (2006) put
forward that as PER is widely used, all necessary data used to compare firms can be found
sufficiently. This means that PER is successful in valuing stock prices. However, Bierman (2002)
suggests that PER can need adjusting. PER is also only useful in the specific industry of the firm, and
cannot be used to compare firms across the whole market.
To conclude, while the PER model is the most popular method of Valuation, it does have various
disadvantages and should never be used solely to valuate a market price for a share.

4. References
Anderson, K Brooks, C.(2006) Decomposing the Price-Earnings Ratio, Journal of Asset Management,
6,6, 456-469
Arnold, G.(2013) Essentials of Corporate Financial Management,2nd Edition. Pearson
Bierman, H(2002). The Price-Earnings Ratio, The journal of portfolio management, 28, 4, 57-60
Data was found using uk.reuters.com and uk.yahoo.finance.com
Specific pages
http://uk.reuters.com/business/quotes/overview?symbol=TSCO.L
https://uk.finance.yahoo.com/q/ks?s=TSCO.L
https://uk.finance.yahoo.com/q/ks?s=SBRY.L
Tesco Balance sheet
http://www.tescoplc.com/index.asp?pageid=267