QUESTION: Using relevant investment appraisal method/s, determine whether Bigvest Company should invest in Zola Budd Project, with reference to the minimum investment criteria.

INFORMATION TO QUESTION: Bigvest Company (or Bigvest) is a proudly South African multinational corporation listed on the Johannesburg Stock Exchange (JSE) with a market capitalisation of R200 billion as at 31 August 2023 financial year-end. Bigvest Company is a holding entity which invests in unique business ventures across the country and has a strong presence in different regions across Africa. The company has interests in financial services, mining, logistics, clothing, personal care, beverages and food products. Bigvest has different ownership structures in its related entities, including wholly and partly owned subsidiaries, joint ventures, once-off or limited-timespan projects, significant or minority shareholding, agency and franchising. The companys head offices are in Kempton Park, South Africa, where the Investment Board (which is responsible for all the investment decisions of the company) is based. The Investment Board sets out different minimum investment criteria which need to be met before investing in a new capital project (acquisition of assets apart from entities with running operations) or in a target company (with already running operations).

For capital projects, the requirement is that the project should yield a minimum profitability index of 1,05 and have a payback period (discounted) that is not longer than five years. The company may undertake as many capital projects as possible if funds permit, but where the company can only choose one of the given alternatives (because initiatives on the different projects cannot coexist), then the one that yields the shortest payback period will be chosen, provided that the minimum investment criteria are still met.

For investing in target companies, the minimum investment criteria are as follows: The target company must have been in existence for at least 4 years; and The target company must have received an unqualified audit report for the 3 preceding financial years; and The financial performance in the target companys latest audited financial year should meet the following minimum requirements (using closing balances where necessary): o Minimum interest cover of 8 times; and o A debt-equity ratio of not greater than 75%; and o Minimum return on capital employed of 20%. In computing ratios and where applicable, the Investment Board uses Net operating profit after tax (NOPAT) as a standard measure of sustainable earnings before interest and after tax.

INVESTMENT PROJECTS FOR 2023/2024

The Investment Board has already identified possible new investments for the 2024 financial year and some preliminary due diligence and engagements have already been initiated. The potential investments are as follows:

Zola Budd Capital Project

While the negotiations with the GBS team were underway, the Investment Board embarked on a breakaway strategy session where it wanted to consider an alternative capital project, Zola Budd, as a different way of entering the highly competitive passenger transportation industry. The session was facilitated by Strata Taxi Consultants who are the market leaders in taxi industry research. They also have strong affiliations with different taxi associations across the country. They have just submitted an invoice for R26 million for the strategy session they hosted which is already due. Subsequent to the strategy session, the Investment Board has established the following:

As an alternative to GBS, Bigvest can purchase a fleet of brand-new minibuses from Toyota Commercial Limited with a budget of R230 million payable upfront in full. Each minibus is diesel-fuelled, carries up to nine passengers and costs R1 150 000. For the next 5 years, these minibuses will be used for long distance passenger transportation (inter-province travel) as they offer great comfort to travellers. At the end of the 5-year period, these minibuses will be sold at R150 000 each. Each minibus comes with a free 3-year/180 000 kilometres (km) maintenance plan worth R60 000 (viz. Bigvest will have its fleet serviced for free for the next 3 years or up until the minibus has reached 180 000 km, whichever occurs first). Bigvest will extend the maintenance plan upon expiry on the same terms and cost. The extended maintenance plan is paid upon expiry of the original maintenance plan.

Passengers using minibuses need to book their bus ticket in advance, anything from a day before the trip up to 60 days. The bookings will be done on Bigvest Companys existing website or via an App that will be developed and launched at the start of the project at a cost of R4,6 million. Alterations to the website will be made by one of the Head Office full-time IT specialists who is on a fixed annual salary of R740 000 (an external IT consulting company would get paid a once of R140 000 for similar work). Once-off graphics, copyright administration and other website-related costs are expected to be R60 000. Upfront permit registration, licensing and taxi association fees will cost R290 000 for the entire fleet.

On average, each minibus will generate about R1,02 million annually in revenue, and the revenue is expected to remain constant until the end of Year 3. Revenue will increase by 4,9 % in Year 4 and remain at that level for the foreseeable future. Minibus drivers will be paid an annual salary of R250 000 each, which also includes accommodation and out of town costs they might incur. The minibus drivers will be on a fixed 5-year term contract, and each driver will be assigned to his/her own minibus for the duration of the contract.

Each minibus is expected to travel 50 000 km per annum. The fuel consumption of each minibus is 8,5 litres per 100 km and this is not expected to change for the life of the minibuses. Bigvest already has fuel storage tanks in major depots across the country for the refilling of its logistics business fleet. Fuel is usually kept at sufficient levels and therefore, for the next 5 years, the minibuses will also make use of these depots to refill. Diesel is currently sold at an average price of R22,20 per litre throughout the country (however, Bigvest buys its diesel at R20 per litre). These prices are forecasted to remain the same for the next 5 years. Other operating costs (insurance, repairs and maintenance, road tariffs, additional personnel, etc.) are estimated at 20% of gross revenue.

Assume the South African Revenue Services (SARS) will allow a wear and tear of 6 years on brand new minibuses. For tax purposes, assume all income and expenses (including other capitalised expenses) are fully taxable and deductible in the same period the income is received, or the expense is paid, unless stated otherwise. Ignore working capital investment, unless specifically addressed above.

Other information relating to Bigvest Company

Assume a weighted average cost of capital of 16% in evaluating all investment projects.

The South African corporate taxation rate is 27%.