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

Understanding the Question :
Tesco, a leading super market group in UK has expanded it's business to Morocco.
But, due to the issues faced in Morocco, the management has decided to either
shut down the operations in Morocco or sell the business to the local investor.
There are 3 options available in front of the company's management and let us
evaluate each of these 3 options and find out the best available option in
financial terms :
Answer to question no.1
a) Calculation of NPV for option 1
(Amount in Millions)
	Year	Inflow	Discounting factor@7%	Discounted value	Outflow	Discounting factor@7%	Discounted value
	2021				10	0.93	9.35
	2022	8.20	0.87	7.16
	2023	8.45	0.82	6.89
	2024	8.70	0.76	6.64
	2025	8.96	0.71	6.39
		Total		27.08			9.35
		Net Present value	(27.08-9.35)	17.73
b) Calculation of NPV for option 3
	Year	Inflow	Discounting factor @5.5%	Discounted value
	2020	10	1.00	10.00
	2021	4	0.95	3.79
	2022	2	0.90	1.80
		Net Present value		15.59
Answer to Question no.2
			Option 1	Option 2	Option 3
	NPV		17.73	14.00	15.59
	Advice :
	Management has to proceed with cutting down the operations in Morocco
	as the NPV for Option 1 is higher than Option 2 & Option 3.