Tesco Plc

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The increase in the value of Tesco Plc of  790 million under the net asset value approach stems from the increase in the net assets. This differs from the increase in equity value of Tesco Plc through the price earnings multiple model, which shows an increase of 9,597 million. Such discrepancy is due to the approach taken by the model. The price earnings multiple tool values the company from the income perspective rather than the net asset value.

Therefore the value of the company will be subject to the profits made by the corporation. In accounting, the capital expenditure entailed in the purchase of non-current assets does not affect the income of the company. The profitability of the firm will be influenced by the economic benefits that such tangible investments will provide to the business enterprise. These will probably be higher than such capital cost in order to aid an increase in revenue.

Therefore if an organization is facing an increase in net assets and a rise in profits, like Tesco Plc, then the value of the company under the price earnings multiple method will be much higher than the net asset value approach due to the greater economic profit attained. Empirical evidence suggests that the price earnings multiple technique is the most popular method that is used in practice to appraise companies. The main advantage of this valuation model is that it aids investors in detecting over-valuations or under-valuations of companies arising from slow inefficient capital markets (Pike R.et al 1999, p 100).

However, the price earnings ratio should be considered carefully by financial analysts and investors because it may mislead investors that are evaluating the company to buy equity in. Corporations with a fallen or rising stock price may be influenced from directors who are purchasing or disposing of their shares in such organization (Kennon J. ) In addition, the truth and fairness of the profitability figure, which highly affects the price earnings ratio, should be considered meticulously.

It is not the first time that profit figures are inflated through changes in accounting policies or new accounting measurement basis with the intention of fooling the market. The classical example that comes to mind is the Enron incident. Through the fair value accounting model applied by the aforesaid organization, this corporation was able to portray unrealistic profit figures and mislead the capital market for a considerable time. The net asset value approach, price earnings multiple model and the discounted cash flow technique again differ from the perspective taken.

In the latter model, a cash flow approach is taken. This significantly differs from the net asset value method like the price earnings system. However, the price earnings multiple tool is different from the cash flow technique because the profit generated by the company is different than the free cash flow attained by the organization. Under profitability non cash expenditure like depreciation are deducted from the profit, which are not considered in the cash flow computation.

The expenditure and revenue is also accounted for when incurred in the income statement and not when paid. Thus discrepancies will arise between these two figures due to such different calculations leading to a different value of the company. Indeed under the price earnings multiple tool a rise in Tesco Plc value of ? 9,597 million was noted, while an increase of ? 459 million arose in the discounted cash flow technique. The limitations of the discounted cash flow method are similar to those of the price earnings system.

In this respect, I suggest that the price earnings ratio is chosen to evaluate the company in view of the popularity it entails in the market, since the disadvantages of both methods are similar.

References: Answers.com. Tesco Plc (on line). Available from: http://www. answers. com/topic/tesco-plc-adr (Accessed 25th May 2007). Institute for Transportation and Development Policy. Tesco Plc (on line). Available from: http://www. itdp. org/SR/read_SR/Tesco. pdf (Accessed 25th May 2007).

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