Two all equity financed companies, Simba Ltd and Yanga Ltd are planning to pursue different investment projects that will last for 4 years. Simba Ltd's investment requires TZS 1billion and will yield cash inflows of TZS 800 million in each of the years 1 to year 4. Yanga Ltds' investment on the other hand requires an initial outlay of TZS 5 billion and will produce cash inflows of TZS 1 billion in each of the years 1 to 4. The cost of capital for the investments to be made by Simba Ltd and Yanga Ltd are 15% and 20% respectively. Assume the economic depreciation is at the same as accounting depreciation following straightline.
Required
i. Calculate the Values of NPV of the projects by both companies
ii. Determine the market value added by both companies and comment on the results.

Answers

Answer 1
Answer:

i. To calculate the NPV of the projects for both companies, you need to subtract the initial outlay from the total cash inflows discounted by their respective cost of capital. For Simba Ltd's investment, this works out to be:


NPV = TZS 800 million x (1/(1 + 0.15)1) + TZS 800 million x (1/(1 + 0.15)2) + TZS 800 million x (1/(1 + 0.15)3) + TZS 800 million x (1/(1 + 0.15)4) - TZS 1 billion


= TZS 2,355,700,000



For Yanga Ltd's investment, this works out to be:


NPV = TZS 1 billion x (1/(1 + 0.20)1) + TZS 1 billion x (1/(1 + 0.20)2) + TZS 1 billion x (1/(1 + 0.20)3) + TZS 1 billion x (1/(1 + 0.20)4) - TZS 5 billion


= TZS 836,491,020



ii. The market value added (MVA) of a company is the increase in the company’s market value due to the implementation of the investment project. The MVA of both Simba Ltd and Yanga Ltd can be calculated as:


MVA = NPV - Depreciation


For Simba Ltd:


MVA = TZS 2,355,700,000 - TZS 1 billion


= TZS 1,355,700,000



For Yanga Ltd:


MVA = TZS 836,491,020 - TZS 5 billion


= -TZS 4,163,508,980



From the results, we can see that Simba Ltd has a positive MVA of TZS 1.3 billion whereas Yanga Ltd has a negative MVA of TZS 4.2 billion. This suggests that Simba Ltd’s investment project is more beneficial to the company than Yanga Ltd’s investment project.

To know more about depreciation, refer here:

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Answer Details:

Grade: High School

Chapter: Liquidity

Subject: Social Studies

 

Keywords:

liquidity, liquid assets, possessions, substantial amount, expenses, saving accounts, equipment, electronic manufcaturers