Question

Tesco is the largest chain of supermarkets in the United Kingdom. The have expanded internationally and have recently also opened stores in Morocco. However, Tesco has since experienced a variety of issues with the Moroccan market. As business development analyst you only see the three following options for Tesco business in Morocco: Today is December 31, 2020. Suppose you have the following information about the financial implications of Tesco’s three strategic options. Option 1: Scale down operations Tesco immediately starts to scale down its operations and plans to eventually leave the Moroccan market effective as of Jan. 01, 2026 (i.e. after 5 more years). At the end of 2021, Tesco operations in Egypt are projected to generate a loss of £10 million. However, due to the effects of scaling down operations and a number of efficiency increases, Tesco estimates a profit of £8,2 million at the end of 2022, which is then expected to increase by 3% on a yearly basis until Dec. 31, 2025. All forecasts for this option are based on assumptions and considered as risky. Option 2: New local partners The NPV of acquiring new local partners has already been calculated for you: £14 million Option 3: Sell business entirely Tesco immediately sells its Moroccan operations to a local investor. The local investor is willing to pay a total £16 million, in three parts of £10 million (today) and £4 million (on Dec. 31, 2021) and £2 million (on Dec. 31, 2022). Since the local investor has also presented a bank guarantee for the whole acquisition price (issued by a well-known British bank), option 3 is considered to be risk-free. The risk-free interest rate is 1,5% EAR. Tesco continuing operations in Morocco are seen as risky and the appropriate risk premium is 7%.

a. Calculate the net present values (NPVs) of options 1 and 3 indicated above. b. Clearly indicate which option (Option 1, Option 2 or Option 3) should be chosen by Tesco's management, and explain the reasons for your choice in one or two sentences.

Answer 1

Based on the given data, pls find below workings:

Based on the above, the NPV are all the three options are provided;

- Option 1: Based on the NPV criteria, Option 1 should be chosen by the firm as the same is higher than any other option; However, one need to agree the fact that these are based on the estimated cash flows and thus there is a senstivity factor to that extent of whether the said estimates are achievable or not;

- Option 2: This option is straight forward to find local partners and run the business; While the NPV is posititve GBP 14 Mn, again the same risk of sensitivity on the estimated cashflows apply to this option as well; Also, compared to any option, this option can be given the lowest preference.

- Option 3: This option as well is giving the positive NPV and also much nearer to the NPV of Option 1; However, there are two factors to be considered here. One factor is that the loss making division is completely gettign divested and hence no risk from the operational profits or estimates; Second factor is that the Proceeds from the Divestment are completely secured thru a Bank Guarantee from a renowned Bank;

Based on the above observations, it would be wise to go for either Option 3 (clear transaction with no Risk) or Option 1 (with slightly higher NPV than Option 3, however risk fo sensitivity on the estimates);

With an option to proceed with only one case, it is recommended to go for Option 3.