CAIE A-Level Business A2 10.3 Investment Appraisal Questions

Refer to Table 1.1. Calculate the payback period for SCC's new factory.

All in $000
(150)+20+40+80=(10)

10/100 $\times 12=1.2$ so 3 years and 1.2 months / 3 years 2 months / 3.1 years / 3 years and 36.5 or 37 days (1)

Refer to Table 1.1. Calculate the accounting rate of return (ARR) for SCC's new factory.

ARR= average profit/average investment $\times 100$

OR where the average investment $=\frac{\text { initial capital cost }+ \text { residual capital value }}{2}$ (Maximum 1 mark, if no valid calculation)

Average investment $=(150 \mathrm{~m}+0) / 2=75 \mathrm{~m}(1)$

OR

Total net cash flow (all $m) = 240 - set-up costs 150 = 90. (1)

90/4 = 22.5. (2)

OR

$22.5 / 75 \times 100(2)$$22.5 / 75 \times 100=30 \%(3)$

Common error - forget to deduct original cost $=240 / 4=6060 / 75 \times 100=80 \%$ (2)

\% not needed for full marks

Alternative formula: average profit / initial investment x 100

22.5 / 150 = 15\% (2)

\% not needed for full marks

Incorrect units, e.g. $30 (2)

Evaluate whether SCC should invest in the new factory.

3(c)

OFR for 3(a) and 3(b)

Indicative content

Responses may include:

AO1 Knowledge and understanding

- Knowledge of IA methods, such as payback, ARR, but also net present value (NPV).

- The new production unit will increase capacity so generic knowledge of capacity utilisation.

- Knowledge of other relevant quantitative or qualitative factors.

AO2 Application

Limited application, ${ }^{\text {APP }}$ applies knowledge to SCC once.

Developed application, ${ }^{\text {APP }}+{ }^{\text {APP }}$ applies knowledge to SCC twice

- The new production unit will increase capacity for bespoke items.

- Factories currently operating at 85%.

- The new production unit will also be used to develop the new products made from recycled textile materials.

- There will be a need for more trained employees to make the clothing and these are in short supply.

- It may be possible to promote some trained employees from the original two factories.

- Payback (year 4 ) and ARR is quite high ( 30% ) (OFR here).

- Relies on demand for bespoke items increasing as well as successful market entry into market for clothing made from recycled textiles.

- SCC are intending to take a bank loan to finance the new unit, which will attract interest payments/increase gearing.

3(c)

AO3 Analysis

Limited analysis ${ }^{\mathrm{AN}}$ - candidate shows one link in the chain of analysis.

Developed analysis L2AN - candidate shows two or more links in the chain of analysis.

- Development of application points, in terms of the likely advantages and disadvantage to SCC of the new production unit, including impact on costs, reliance on future sales and revenue.

- An increase in capacity is needed if demand increases, as they are working at 85% currently. This will enable SCC to produce more clothing. AN This should lead to higher sales and revenue, as suggested by the forecast figures. L2 AN

- However, it may be difficult to staff the new unit with specialist workers, as they may be hard to find in Country Z. This may mean that Sunil needs to set up his own training sessions, which could be costly.

- Wage rates may also need to be higher, given the scarcity of skilled workers, adding to costs AN and potentially decreasing profits if prices cannot be increased. L2 AN

- Given SCC's current product portfolio, the main products being mass-produced clothing, the marketing mix will need to be changed to target 'environmentally aware' customers, this could add to marketing costs ${ }^{\text {AN }}$ possibly decreasing profits if it takes time to reach these customers and increase sales. L2 AN

AO4 Evaluation

Limited evaluation ${ }^{[\text {vxil }]}$ - limited supported judgement and/or a weak attempt at evaluative comment.

Developed evaluation ${ }^{\text {L2 }}$ - supported judgement and/or reasonable evaluative comment.

Developed evaluation in context ${ }^{\left\lfloor 3,{ }^{\text {vat }}\right\}}$ - supported judgement in context and/or reasonable evaluative comment in context.

- Either conclusion rewardable as long as it is justified.

- In the short term, this will be costly ( $ 150000 ) and will the bank be willing to lend?

- How secure may the sales forecasts be, given the economic situation in Country Z and the other export countries.

- There is considerable risk involved, especially in the untried market for recycled clothing. Is Sunil (and family) willing to take the risk?

Accept all valid responses.

Indicative content

Refer to Table 1.1. Calculate the net present value (NPV) of the new grinding machine.

Indicative content

Evaluate whether GBS should purchase the new grinding machine.

Level

AO2 Application 2 marks

AO3 Analysis 2 marks

AO4 Evaluation 6 marks

3

5-6 marks

Developed evaluation in context

- A developed judgement/conclusion is made in the business context.

- Developed evaluative comments which balance some key arguments in the business context.

2

2 marks
Developed application of relevant point(s) to the business context.

2 marks
Developed analysis that identifies
connections between
causes, impacts and/or
consequences.

3-4 marks

Developed evaluation

- A developed judgement/conclusion is made.

- Developed evaluative comments which balance some key arguments.

1

1 mark

Limited application of relevant point(s) to the business context.

1 mark
Limited analysis that identifies
connections between
causes, impacts and/or
consequences.

1-2 marks

Limited evaluation

- A judgement/conclusion is made with limited supporting comment/evidence.

- An attempt is made to balance the arguments.

0

0 marks

No creditable response.

0 marks

No creditable response.

0 marks

No creditable response.

3(c)

Indicative content

A01 Knowledge and understanding

Limited knowledge K will be demonstrated through knowledge of one factor in the decision.

Developed knowledge K+K will be demonstrated through knowledge of two or more factors in the decision.

- Understanding of investment appraisal methods - NPV, ARR, payback period.

- Understanding of possible qualitative factors in investment decision - business attitudes, risk, impact on stakeholders, external factors, consistency with business objectives/strategy availability of finance.

AO2 Application

Limited application, ${ }^{\triangle P P}$ applies knowledge to GBS once.

Developed application, ${ }^{\text {APP }}+{ }^{\text {APP }}$ applies knowledge to GBS twice.

- Requirement for skilled operator.

- Loan finance is available.

- Use of data in Table 1.1 from manufacturer and Mo's experience.

- Impact on unit costs.

- Use of answers to Q3(a) and 3(b) (OFR applies).

- NPV is positive $ 22000.

- ARR is 16.4%.

- Payback and is in 4th year, 3 years and 10.3 months or 3.86 years.

- Discounted payback is 4 years 3.5 months or 4.29 years.

3(c)

AO3 Analysis

Limited analysis ${ }^{\mathrm{AN}}$ - candidate shows one link in the chain of analysis.

Developed analysis L2AN - candidate shows two or more links in the chain of analysis.

- Payback is within the 4th year so the investment is forecast to be profitable AN and therefore potentially worth investing in L2AN.

- NPV is positive and should therefore be considered as a worthwhile investment AN.

- GBS may need to finance the investment through borrowing which will increase the gearing of GBS AN and this increases risk for shareholders L2AN.

- The investment would enable GBS to meet the increasing demand for its products and therefore potentially increase profit AN.

- The grinding machine would decrease unit costs and therefore GBS could set lower prices AN which should result in an increase in demand L2AN.

- NPV (positive) and ARR is higher than 5% cost of finance indicating GBS should go ahead AN.

AO4 Evaluation

Limited evaluation ${ }^{\text {гval }}$ - limited supported judgement and/or a weak attempt at evaluative comment.

Developed evaluation ${ }^{\text {L2 }}$ - supported judgement and/or reasonable evaluative comment.

Developed evaluation in context ${ }^{\lfloor 3 \text { rwa }\rfloor}$ - supported judgement in context and/or reasonable evaluative comment in context.

- Data and investment appraisal methods strongly support the purchase but are the figures accurate and reliable?

- Is a 5 -year life realistic? Can data over a 5 -year future period be relied on?

- Qualitative factors may be as or more important than calculations.

- May not be reliable or accurate - can the manufacturer's data be relied on? They are trying to make a sale so data may be optimistic plus Mo has not done any market research or research into cost savings (relied on experience).

- Are there any other possible investments or changes that will meet GBS's needs? Little evidence of other possibilities other than the bullet points in last section - might finance be better spent on one of these?

- Can GBS afford another course of action as well as the purchase if it goes ahead?

- These points support the conclusion that more detailed research into sales and cost savings including checking the existing data is needed before making a decision.

- Is there a time scale for making the decision?

- Are there other possible ways for growth to occur? Need to investigate before deciding.

- In view of other possible options/actions in the case more research would be justified before deciding.

Accept all valid responses.

Refer to Table 1.2. Calculate the accounting rate of return (ARR) of automating production.

4(a)

Note: No mark for non-syllabus equation: Average profit/capital cost × 100

Evaluate whether SF should invest in automating production.

4(b)

0 &
0 marks

No creditable response.

0 marks

No creditable response.

0 marks

No creditable

response.

0 marks

No creditable response.

\end{tabular}

Indicative content

AO1 Knowledge and understanding

Limited knowledge K will be demonstrated through knowledge of one factor in the decision.

Developed knowledge K+K will be demonstrated through knowledge of two or more factors in the decision.

- Automation will reduce the relative number of employees.

- Other factors in decision:

- Cost

- Availability of finance

- Impact on employees

- ARR

- Payback results and NPV

- Control over quality

- Benefits/limitations of alternatives such as outsourcing

- Production may/should increase

- Less mistakes made

AO2 Application

Limited application, ${ }^{\mathrm{APP}}$ applies knowledge to SF once.

Developed application, ${ }^{\triangle \mathrm{PP}}+{ }^{\triangle \mathrm{PP}}$ applies knowledge to SF twice.

Use of results to investment appraisal OFR/case study information.

- ARR is above criterion rate of 20%.

- Payback is 4 years and 4 months ( 4.36 years). Allow within 5 years. Allow 132.7 days.

- Sales forecast data shows clear upward sales trend of ice cream.

- Capacity utilisation is 90%.

- Plans to export to country D.

- Possible impact of joining free trade area.
\end{tabular}

4(b)

AO3 Analysis

Limited analysis ${ }^{\mathrm{AN}}$ - candidate shows one link in the chain of analysis.

Developed analysis L2AN - candidate shows two or more links in the chain of analysis.

- Reduction in number of employees will reduce unit labour costs of production AN. This will help reduce unit costs and could result in a higher profit margin L2 AN or a lower selling price leading to increased sales L2 AN.

- Outsourcing could reduce control over quality and increase chance of poor-quality food reaching customers and consumers resulting in dissatisfaction AN and therefore a loss of sales L2AN.

- Joining free trade area in January 2025 may lead to increased exports increasing pressure on capacity AN therefore SF need to increase capacity to meet expected demand L2AN.

- The capital investment cost required for automating would mean sacrificing alternative investment decisions AN.

AO4 Evaluation

Limited evaluation ${ }^{[\text {wat }]}$ - limited supported judgement and/or a weak attempt at evaluative comment.

Developed evaluation ${ }^{\text {L2 }}{ }^{\text {was }}$ - supported judgement and/or reasonable evaluative comment.

Developed evaluation in context ${ }^{\text {[ } 3 \text { ] }}$ - supported judgement in context and/or reasonable evaluative comment in context.

- Elements that the evaluation/judgement might depend on:

- Accuracy of the data over 6 years.

- Significance of retaining control over quality for food products.

- Depends on whether the increase in demand is long-term.

- Reaction of employees and consideration of duty to them.

- Availability of finance.

- How long will it take to implement?

- Impact on quality.

- Availability of appropriately trained/skilled labour.

Accept all valid responses.