Answer to Question #67921 in Financial Math for Heisenberg

Question

Your friend has some money to invest and is deciding between an investment in Dolly Ltd or Yaalu Ltd. In the most recent reporting period, Dolly Ltd made a profit after tax of R1 250 000 after investing R8 500 000, compared to Yaalu’s after-tax profit of R1 000 000 after investing R6 000 000. The average return that investors are currently looking for in the market is 15% (cost of capital). On the basis of the higher profit achieved, your friend believes that Dolly Ltd is the superior investment. Discuss your friend’s investment choice. In doing so, suggest other financial data that should be considered. Discuss and analyse the benefits and limitations of each. What non-financial data may be of interest to inform your friend’s investment decision?

Answer 1

If Dolly Ltd made a profit after tax of R1 250 000 after investing R8 500 000, compared to Yaalu’s after-tax profit of R1 000 000 after investing R6 000 000. and the average return that investors are currently looking for in the market is 15%, then the cost of capital of Dolly Ltd is 1 250 000/8 500 000 = 0.147, so it is below the average, but the cost of capital of Yaalu is 1 000 000/6 000 000 = 0.167, so it is abov the average and is better for your friend.
The other financial data that should be considered is internal rate of return (IRR), payback period (PBP), net present value (NPV), some risks etc. There are some benefits and limitations of each, because all this data provide some partial information. Such non-financial data as overall information about the companies, some expert's opinions etc.