Question 1
Vista Bikes Ltd manufactures bicycles for city commuters. The operations manager is considering investing in a new machine to assemble electric bicycle frames. The machine would require a large initial outlay and is expected to generate net cash inflows over several years.
Define the term investment appraisal.
[2]
Question 2
GrowPod, a small business producing indoor herb gardens, is choosing between two new packaging machines. Machine A has a payback period of 18 months. Machine B has a payback period of 30 months but is expected to operate for longer and generate higher cash inflows after year 3.
Outline two limitations for GrowPod of using payback period to appraise the two machines.
[4]
Question 3
SproutBox (SB) is a small private limited company that produces indoor herb-growing kits for restaurants. SB is considering purchasing automated shelving for its packing area. The finance manager has set a maximum acceptable payback period of 3.5 years.
The forecast data for the investment are shown below.
| Item | Forecast figure |
|---|---|
| Initial investment cost | $96 000 |
| Forecast annual net cash inflow | $32 000 |
| Expected useful life | 4 years |
Item | Amount ($) | Time (years) |
|---|---|---|
Initial investment cost | 96,000 | |
Forecast annual net cash inflow | 32,000 | |
Expected useful life | 4 |
Calculate the payback period for the automated shelving investment. Show all your working.
[2]
Comment on whether SB should accept the investment using the payback period.
[2]
Question 4
Meral Foods operates three food trucks. It is considering buying a refrigerated van to expand into private events. The finance manager has calculated that the van would have an average rate of return (ARR) of 16 %, compared with Meral Foods' target return of 12 %.
Explain one advantage and one disadvantage for Meral Foods of using ARR to appraise the refrigerated van investment.
[4]
Question 5
BlueWave Surf School is considering purchasing an online booking system. The owner expects the system to reduce administration time and increase bookings in the summer. However, the cash inflows are uncertain because demand depends heavily on weather and tourism levels.
Explain why forecast net cash flows are important in investment appraisal for BlueWave Surf School.
[4]
Question 6
CycleHub (CH) repairs electric bicycles in a busy city centre. CH is considering buying a diagnostic machine that would allow faster repair times. Demand for electric bicycle repairs is expected to grow, but the technology may change quickly. CH wants any investment to pay back before the end of year 4.
The forecast net cash flows are shown below.
Year | Net cash flow / $ |
|---|---|
0 | ($75 000) |
1 | $18 000 |
2 | $22 000 |
3 | $25 000 |
4 | $28 000 |
5 | $30 000 |
Calculate the payback period for the diagnostic machine. Show all your working.
[3]
Comment on the result of the payback calculation for CH.
[2]
Question 7
Mella Cafe (MC) is a chain of three coffee shops. MC is considering buying a small coffee-roasting machine so that it can sell its own branded roasted coffee. The owners require a minimum average rate of return (ARR) of 10%.
Assume that the listed annual returns are net cash inflows before depreciation and that the machine has no residual value at the end of its useful life.
Forecast data for the machine are shown below.
Item | Forecast figure |
|---|---|
Initial investment cost | 120,000 |
Expected useful life | 5 years |
Year 1 return | 30,000 |
Year 2 return | 34,000 |
Year 3 return | 36,000 |
Year 4 return | 37,000 |
Year 5 return | 39,000 |
Calculate the ARR for the coffee-roasting machine. Show all your working.
[3]
Comment on whether MC should accept the investment using ARR.
[2]
Question 8
NoriPrint Ltd prints labels for cosmetics businesses. It is considering replacing manual inspection with automated quality-control equipment. The finance director has prepared payback figures using forecast net cash flows, including expected cash savings from fewer rejected labels and lower labour costs, and ARR figures using forecast accounting profits after relevant operating costs and depreciation.
Explain one benefit and one limitation for NoriPrint Ltd of using these forecasts in appraising the automated equipment.
[4]
Question 9
Aurea Clinics is considering investing in diagnostic scanning equipment. The finance team has produced payback and ARR results and the chief executive says that the numbers should settle the decision. Some doctors are worried about staff training, patient waiting times during installation and the risk that demand forecasts are too optimistic.
Explain why investment appraisal results may not be the only basis for Aurea Clinics' investment decision.
[4]
Question 10
Coastline Kayaks (CK) manufactures wooden kayaks. CK is considering a solar-powered drying kiln that would reduce electricity use and improve CK's environmental image. The managing director wants the investment to pay back within 3 years.
Forecast net cash flows are shown below.
Year | Net cash flow / $ |
|---|---|
0 | (140 000) |
1 | 35 000 |
2 | 45 000 |
3 | 50 000 |
4 | 55 000 |
Calculate the payback period for the solar-powered drying kiln. Show all your working.
[3]
Explain one limitation for CK of using the payback period to appraise this investment.
[2]
Question 11
Luna Laundry operates self-service laundries in university towns. It is considering opening a new outlet near a large campus. The investment would have a payback period of 14 months and an ARR of . Luna Laundry's bank charges interest on long-term borrowing. The managing director is attracted by the short payback period because the business has had liquidity problems.
Analyse whether Luna Laundry should rely mainly on the payback period when deciding whether to open the new outlet.
[6]
Question 12
ReLeaf Packaging produces compostable containers for restaurants. It is considering two mutually exclusive investments. Option A is a conventional moulding machine with a payback period of 2 years and an ARR of . Option B is an energy-efficient moulding machine with a payback period of 3 years and 6 months and an ARR of . Option B would also reduce energy use and support ReLeaf Packaging's environmental brand image.
Analyse whether ReLeaf Packaging should choose Option A or Option B.
[6]
Question 13
BrightBoard (BB) manufactures display boards for schools. BB is considering two mutually exclusive investments. Option X is a cutting machine. Option Y is a digital printer. BB has limited finance available and must choose only one option.
Forecast data are shown below.
Assume both assets have zero residual value. Treat the forecast annual returns as annual cash returns before depreciation, and use straight-line depreciation. Use the standard ARR formula: , where average investment is the mean of the initial investment and residual value.
Item | Option X: cutting machine | Option Y: digital printer |
|---|---|---|
Initial investment cost | $200 000 | $240 000 |
Expected useful life | 5 years | 5 years |
Year 1 return | $60 000 | $40 000 |
Year 2 return | $60 000 | $60 000 |
Year 3 return | $55 000 | $70 000 |
Year 4 return | $50 000 | $85 000 |
Year 5 return | $45 000 | $90 000 |
Calculate the ARR for Option X. Show all your working.
[2]
Calculate the ARR for Option Y. Show all your working.
[2]
Recommend which option BB should choose, using your ARR calculations and the data above.
[2]
Question 14
FreshLoop (FL) produces compostable food containers for takeaway restaurants. FL is considering a new moulding line. The finance director uses a discount rate of 8% to reflect FL's cost of capital.
Forecast net cash flows and discount factors are shown below.
Year | Net cash flow ($) | Discount factor at 8% |
|---|---|---|
0 | ($180 000) | 1.000 |
1 | $60 000 | 0.926 |
2 | $65 000 | 0.857 |
3 | $70 000 | 0.794 |
4 | $75 000 | 0.735 |
Calculate the net present value (NPV) of the new moulding line. Show all your working.
[4]
Comment on whether FL should invest in the new moulding line using the NPV result.
[2]
Question 15
ClearWave Laundry (CL) operates commercial laundries for hotels. CL is considering water-recycling equipment to reduce water costs and improve its environmental reputation. The finance manager uses a discount rate of 12% because CL's borrowing costs have recently increased.
Forecast net cash flows and discount factors are shown below.
Year | Net cash flow ($) | Discount factor at 12% |
|---|---|---|
0 | ($95 000) | 1.000 |
1 | $28 000 | 0.893 |
2 | $32 000 | 0.797 |
3 | $34 000 | 0.712 |
4 | $36 000 | 0.636 |
Calculate the NPV of the water-recycling equipment. Show all your working.
[4]
Explain one limitation for CL of using NPV to appraise this investment.
[2]
Question 16
KiteLink Logistics (KL) is a small private limited company that delivers medical samples between clinics and laboratories in a large city. KL currently leases petrol vans. A local hospital group has asked KL to reduce delivery times and carbon emissions before renewing its contract.
KL is considering investing in temperature-controlled electric cargo bikes. The city council is trialling new cycle lanes, but there is uncertainty about whether these lanes will become permanent. KL's bank will only lend if the investment appears affordable.
The forecast data for the investment are shown below.
Item | Forecast figure |
|---|---|
Initial investment cost | USD 180,000 |
Expected useful life | 4 years |
Forecast net cash inflow: year 1 | USD 42,000 |
Forecast net cash inflow: year 2 | USD 55,000 |
Forecast net cash inflow: year 3 | USD 66,000 |
Forecast net cash inflow: year 4 | USD 72,000 |
Maximum acceptable payback period | 3.5 years |
Target ARR | 9% |
Discuss whether KL should invest in the electric cargo bikes.
[10]
Question 17
Kaito Bakes (KB) is a small private limited company that produces premium frozen pastries for cafes and independent supermarkets. KB has built its reputation on hand-made quality, but demand has recently increased after a regional supermarket chain offered KB a three-year supply contract. The supermarket contract would require more consistent output and lower unit costs. KB has limited retained profit and can only afford one of the following investment options.
Option A: Buy a semi-automated pastry machine. The initial investment cost would be USD 180 000. Forecast net cash inflows, excluding the initial cost, are USD 75 000 in year 1, USD 70 000 in year 2, USD 55 000 in year 3 and USD 45 000 in year 4. The machine would reduce waste and improve consistency, but some bakers fear that their skills would be less valued and that redundancies could occur. The machine may also reduce the hand-made image of KB’s products.
Option B: Convert an unused shop into a cafe under the brand name KB Kitchen. The initial investment cost would be USD 130 000. Forecast net cash inflows, excluding the initial cost, are USD 30 000 in year 1, USD 45 000 in year 2, USD 55 000 in year 3 and USD 60 000 in year 4. The cafe would allow KB to sell directly to consumers and strengthen its brand, but the town centre has many competitors and KB would need to recruit and train service staff.
KB’s owners want an investment that supports growth without putting too much pressure on cash flow.
Using the information above, recommend whether KB should choose Option A or Option B.
[10]
Question 18
AquaTrail Adventures (ATA) is a family-owned business offering guided river trips and outdoor education programmes. A recent storm damaged some of ATA’s equipment, and the business has had liquidity problems during the winter season. ATA’s bank charges 9 % interest on long-term borrowing. The owners want to invest in one project before the next summer season.
Assume that each project has a useful life of four years. The listed annual net cash inflows are all expected project cash flows, and there is no residual value or additional terminal cash flow.
Option A: Buy two electric safety boats. The initial investment cost would be USD 90 000. Forecast annual net cash inflows, including the relevant cost savings and excluding the initial investment, are USD 34 000 in year 1, USD 32 000 in year 2, USD 28 000 in year 3 and USD 24 000 in year 4. The electric boats would reduce fuel costs, improve ATA’s environmental image and make trips quieter for wildlife tours. However, battery performance in cold weather is uncertain and guides would need training.
Option B: Develop a mobile booking app and install secure self-service equipment lockers. The initial investment cost would be USD 70 000. Forecast annual net cash inflows, including the relevant cost savings and excluding the initial investment, are USD 18 000 in year 1, USD 25 000 in year 2, USD 30 000 in year 3 and USD 35 000 in year 4. The app could increase online bookings, reduce administration costs and make it easier to sell off-season activities. However, some older customers prefer telephone bookings and there may be security problems with self-service lockers.
ATA’s owners want the investment to improve profitability, but they are also concerned about liquidity and reputation.
Using the information above, recommend whether ATA should choose Option A or Option B.
[10]
Question 19
UrbanMeds (UM) is an online pharmacy. It is considering two mutually exclusive investments to improve home delivery. Option A is a route-planning system. Option B is an automated dispatch system. UM uses a discount rate of 10%.
Forecast data are shown below.
Year | Discount factor at 10% | Option A net cash flow | Option B net cash flow |
|---|---|---|---|
0 | 1.000 | $(150 000) | $(160 000) |
1 | 0.909 | $55 000 | $30 000 |
2 | 0.826 | $55 000 | $50 000 |
3 | 0.751 | $55 000 | $75 000 |
4 | 0.683 | $55 000 | $95 000 |
Calculate the NPV for Option A. Show all your working.
[2]
Calculate the NPV for Option B. Show all your working.
[2]
Recommend which option UM should choose, using the NPV results and the data above.
[2]
Question 20
OceanHarvest Seaweed (OH) is a worker cooperative that processes locally harvested seaweed into food ingredients for restaurants. Demand is increasing, but OH has limited cash reserves because harvests are seasonal. OH is considering two mutually exclusive investment options.
Option A is an automated electric dryer that would increase output quickly but use more electricity. Option B is a solar drying greenhouse that would support OH's environmental brand image but has lower cash inflows in the early years.
OH's finance manager has prepared the following forecasts.
OH's directors prefer investments that pay back within 3.5 years. They also want to reduce exposure to future energy price increases.
Item | Option A: electric dryer | Option B: solar drying greenhouse |
|---|---|---|
Initial investment cost (USD) | 240000 | 260000 |
Expected useful life (years) | 4 | 5 |
Forecast net cash inflow, year 1 (USD) | 90000 | 50000 |
Forecast net cash inflow, year 2 (USD) | 80000 | 65000 |
Forecast net cash inflow, year 3 (USD) | 70000 | 85000 |
Forecast net cash inflow, year 4 (USD) | 55000 | 95000 |
Forecast net cash inflow, year 5 (USD) | — | 110000 |
Recommend whether OH should choose Option A or Option B.
[10]
Question 21
Orion Assistive Tech (OAT) designs and manufactures specialist equipment for people with physical disabilities. OAT sells mainly to hospitals and occupational therapists. It has a strong ethical mission, but its production delays have recently increased customer complaints. The board has set two financial targets for any new investment: a maximum payback period of 3 years 6 months and a minimum ARR of 10 %. OAT can choose only one of the following investments.
Assume that each investment has a five-year appraisal life, no residual value and no cash flows after year 5. For this question, use the simplified ARR convention: and .
Option A: Install an automated 3D-printing production cell. The initial investment cost would be USD 260 000. Forecast net cash inflows, excluding the initial cost, are USD 95 000 in year 1, USD 90 000 in year 2, USD 80 000 in year 3, USD 70 000 in year 4 and USD 50 000 in year 5. The production cell would reduce outsourcing, shorten delivery times and allow more customized products. However, the technology may become obsolete quickly and production workers are worried about possible job losses.
Option B: Open a demonstration and training centre for occupational therapists. The initial investment cost would be USD 210 000. Forecast net cash inflows, excluding the initial cost, are USD 30 000 in year 1, USD 45 000 in year 2, USD 70 000 in year 3, USD 85 000 in year 4 and USD 95 000 in year 5. The centre would build relationships with therapists, improve customer understanding of OAT’s products and support OAT’s ethical mission. However, demand would depend on referrals from hospitals, and OAT would need to recruit specialist trainers.
Using the information above, evaluate whether OAT should choose Option A or Option B.
[10]
Question 22
Aria Events (AE) organizes conferences for technology businesses. Since the growth of hybrid events, AE has outsourced live-streaming services to a specialist supplier. Outsourcing is flexible, but quality has been inconsistent and several clients have complained about sound delays.
AE is considering purchasing its own live-streaming equipment and software. The equipment would require staff training and may become outdated quickly. AE uses a discount rate of 9% to reflect its cost of capital and the risk of the project.
The forecast data are shown below.
AE's target ARR for investments is 12%.
Year | Forecast net cash flow (USD) | Discount factor at 9% |
|---|---|---|
0 | (300 000) | 1.000 |
1 | 70 000 | 0.917 |
2 | 95 000 | 0.842 |
3 | 115 000 | 0.772 |
4 | 125 000 | 0.708 |
5 | 50 000 | 0.650 |
Evaluate whether AE should purchase its own live-streaming equipment and software.
[10]
Question 23
Sunrise Solar Libraries (SSL) – a social enterprise
Read the resources and answer the questions that follow.
Resource 1 — Background
SSL is a social enterprise that provides solar-powered study spaces and mobile reading lessons in rural communities with unreliable electricity. SSL charges small membership fees to families that can afford them and uses donations to subsidize access for low-income learners. Its mission is to improve literacy while reducing dependence on diesel generators.
Resource 2 — Selected investment appraisal information for three mutually exclusive options
| Option | Initial cost / USD | Payback period / years and months | ARR / % | NPV at 9% / USD | Operational and social effect |
|---|---|---|---|---|---|
| A: mobile solar classroom | 180 000 | 2 years 8 months | 18 | 22 000 | reaches isolated villages but has high maintenance costs |
| B: six fixed solar libraries | 260 000 | 4 years 1 month | 24 | 61 000 | provides safe study spaces for more learners |
| C: tablet loan and learning app | 120 000 | 1 year 10 months | 14 | 8 000 | quick to launch but excludes villages with weak internet |
Resource 3 — Finance and constraints
SSL has cash reserves of USD 70 000. A foundation will provide a grant of up to USD 100 000 only for investments with clear renewable-energy benefits. SSL can borrow up to USD 160 000 at an annual interest rate of 9%. Trustees normally prefer projects with a payback period of less than four years, unless the social impact is strong.
Resource 4 — Stakeholder views
In a social-media survey of 8 400 followers, 68% said that safe evening study spaces were more important than online learning. A village leader stated: "Children cannot learn after sunset if the only light is from a smoky generator."
Using Resource 2, describe one difference between payback period and average rate of return (ARR) as investment appraisal methods for SSL.
[2]
Using Resources 2 and 3, analyse the suitability of using payback period and ARR when deciding which investment SSL should choose.
[6]
Using all the resources provided and your knowledge of business management tools and theories, recommend a plan of action for SSL over the next five years.
[17]
Question 24
Harvest Loop Kitchens (HLK) – a social enterprise
Read the resources and answer the questions that follow.
Resource 1 — Background
HLK collects surplus fruit and vegetables from supermarkets and farms, then prepares low-cost meals for older people and families facing food insecurity. Any surplus is reinvested into nutrition education and employment training for people who have been unemployed long-term.
Resource 2 — Investment appraisal information for three possible investments
| Option | Initial cost / USD | Payback period / years and months | ARR / % | NPV at 10% / USD | Social and environmental effect |
|---|---|---|---|---|---|
| A: second kitchen and blast chiller | USD 320 000 | 3 years 6 months | 21% | USD 38 000 | increases meal output by 40 000 meals per year |
| B: anaerobic digester and cold store | USD 240 000 | 5 years 2 months | 16% | USD 64 000 | reduces waste-disposal costs and produces compost for partner farms |
| C: electric delivery vans | USD 90 000 | 2 years 0 months | 12% | USD -5 000 | improves delivery reliability and visibility in the city |
Resource 3 — Finance and risk
HLK can borrow a maximum of USD 200 000. A donor has offered to match crowdfunding up to USD 125 000 if the investment is clearly linked to food poverty. HLK's finance manager is concerned that food prices and energy costs could make forecast net cash flows unreliable.
Resource 4 — Stakeholder views
HLK has 72 000 social-media followers. A recent post showing meals delivered to older people was shared 19 000 times. A volunteer coordinator said: "Supporters give most generously when they can see meals reaching people, not when we talk about equipment."
Using Resource 2, explain one reason why a project with a longer payback period may still be financially attractive to HLK.
[2]
Using Resources 2 and 3, analyse two financial challenges HLK faces when appraising the investment options.
[6]
Using all the resources provided and your knowledge of business management tools and theories, recommend a plan of action for HLK to increase its long-term financial and social sustainability.
[17]
Question 25
ReMade Mobility (RMM) – a social enterprise
Read the resources and answer the questions that follow.
Resource 1 — Background
RMM refurbishes donated wheelchairs and mobility aids, then sells them at affordable prices or donates them through local clinics. RMM also trains young people with disabilities in repair skills. Demand is rising, but many customers wait more than eight weeks for a suitable wheelchair.
Resource 2 — Investment appraisal information for three possible projects
| Option | Initial cost / USD | Payback period / years and months | ARR / % | NPV at 8% / USD | Operational and social effect |
|---|---|---|---|---|---|
| A: automated paint booth | USD 150 000 | 2 years 0 months | 19% | USD 18 000 | improves product finish but uses solvent-based materials |
| B: CNC cutting and training cell | USD 280 000 | 4 years 8 months | 25% | USD 72 000 | produces custom parts and creates 12 training places per year |
| C: donor relationship software | USD 80 000 | 1 year 5 months | 17% | USD 24 000 | improves repeat donations but does not increase repair capacity |
Resource 3 — Discount-rate sensitivity
RMM currently uses an 8% discount rate. If a grant is not renewed, RMM expects its cost of capital to rise and would use a 13% discount rate. At 13%, the estimated NPV of Option A becomes USD -2 000, Option B becomes USD 9 000 and Option C becomes USD 16 000.
Resource 4 — Stakeholder views
A social-media post about the waiting list received 3 600 comments in one week. One wheelchair user wrote: "A better-looking wheelchair is nice, but getting the right chair sooner changes whether I can go to work."
Using Resource 3, describe one reason why the choice of discount rate matters in net present value (NPV) calculations for RMM.
[2]
Using Resources 2 and 3, analyse how uncertainty affects RMM's use of investment appraisal methods.
[6]
Using all the resources provided and your knowledge of business management tools and theories, recommend a plan of action for RMM to reduce waiting times while remaining financially sustainable.
[17]
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