TIMED MOCK PAPER

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TIMED MOCK PAPER

• This FRIDAY 1st 56 is a timed DR paper with 40
  marks.based on a case study on which Mrs
  Williamson will be setting the other ½ of the
  questions.also worth 40 marks on Mondays
  lesson!
• HWK revise for assessment

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U6 BS unit 4 quiz

• Investment appraisal!

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Outline three business decisions that may require
the application of investment appraisal
techniques.

• When contemplating introducing new products.
• Expansion.
• Investing in new technology

4
Explain why forecasts of sales revenues arising
from an investment may prove to be inaccurate.

• Market research carried out how accurate are
  the forecasts
• Unable to predict competitors reactions
• Unexpected periods of inflation, or rising import
  prices might result in inaccurate forecasts of
  expenditures and affect price levels
• This can lead to a significant reduction in
  actual profits when compared with forecasts.

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Why might investment appraisal be easier to
conduct in a stable economic environment?

• Easier to predict inflation
• More stable monetary policy (interest rates)
• Consumer confidence consistent revenue intake

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Payback
2 mins to do tick tock

• A 500,000 investment creates the following
  return
• Year 1 300,000
• Year 2 150,000,
• Year 3 100,000 and
• Year 4 120,000
• How long will it take to payback?

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The answer to payback

• The sum of year 1 2 450,000 therefore it will
  take 2 years and _____ months
• To calculate how many extra months it will take,
  use the whole next years figures, divide by 12
  months, then calculate how many months it will
  take to generate the remaining outstanding
  debt.
• e.g. 100,000 / 12 months 8333.33
• and there is 50,000 outstanding so 50,000/
  8333.33 6 months
• Therefore the total payback is 2 years and 6
  months

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Another payback Q
2 mins to do tick tock

• Thames Radio is considering investing in new
  broadcasting equipment. The cost of the
  investment is forecast to be 150 000. The
  expected additional revenue from being able to
  broadcast to a larger area is 40 000 per annum.
  
• What is the payback period of this investment?
• Explain one disadvantage of using payback in this
  circumstance.

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Answer

• 150,000 cost
• 40,000 p.a
• 3 years 120,000 where as 4th year 160,000
• Therefore 3 years and ? Months
• So 40,000 / 12 3333.33
• 30,000 / 3333.33 9 months
• Therefore 3 years and 9 months
• Problem very rare for an investment to return
  steady cash back of 40,000 p.a probably
  unrealistic forecast

Or a super quick method 150,000/40,000 3.75
years 3 years and 9 months
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ARR
2 mins to do tick tock

• Chedgrave Printers are appraising the costs and
  benefits from a new piece of machinery. The
  equipment costs 300 000 and has a working life
  of 4 years. The company expects the generate
  revenue of 120 000 each year if they purchase
  the machine.

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Answer

• 120,000 4 years 480,000
• 480,000 300,000 180,000
• 180,000 / 4 years 45,000
• 45,000 /300,000 x 100 15

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The investment appraisal background

• Dantex Ltd produces highly advanced computer
  software for banks. Sales have weakened in the
  past year and it faces a tough decision.
• Should it invest 5 million in a major
  advertising campaign to banks in the U.S.?
• Or should it invest 10 million in developing new
  software tailored to the needs of existing
  customers?
• At present it cannot afford to do both. And with
  interest rates at 10, it is worried about
  borrowing too much to finance investment.

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Investment appraisal carry out payback, ARR
NPV
Just 10 mins to dotick tock
10 discount year 1 0.909 year 20.826 year
3 0.751 year 4 0.683
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Payback _answer

• Advertising costs 5m and in Year 1 (10m-5m)
  5m
• (with 2m potential profit after payback)
• New Product costs 5m and Year 1 (-5m) Year 2
  3m, Year 3 7m
• So 3 years to repay loan
• (with 6m potential profit after payback)

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ARR

• Advertising
• 7m 5m 2m
• 2m/2 years 1 m p.a.
• 1 / 5 x 100
• ARR 20
• New Product
• 16m - 10m 6m
• 6m/4 years 1,500,000 or 1.5m p.a.
• 1.5m/10m 0.15x 100
• ARR 15

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NPV
If you are useless at remembering to subtract
the original cost PUT it in to your calculation
Advertising 6.197m New product
7.288m -5m -5m 1.197
2.288 Therefore New product better by 1.091m
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Next step

• Are there any other factors you think should be
  considered before deciding which option to
  proceed with (or whether to turn them both down)?
• What other questions would you ask to obtain
  further information before you make a final
  decision on which project to proceed with?

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Financial data on Dantex

• Net cash position (cash minus overdraft) 2m
• Acid test 0.62
• Gearing 55 (Loans 22m capital employed 40m)
• Current ROC 8
• Access to share/equity finance very good, as
  several major banks are keen to take a stake of
  up to 49 in the business (which is currently
  owned entirely by the Danton family). There would
  be no problem in raising 8m.

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Other info you might need

• Questions on data reliability
• The software development manager made his
  estimates after detailed consultation with the
  marketing manager and the finance director, plus
  a quantitative research study in the U.S.
  conducted by an independent research company.
• Dantex has a history of highly accurate
  forecasting, which is considered a matter of
  pride among executives.
• The software development manager has worked for
  the company for 8 years and is known for her
  integrity.
• Objectives
• The chairman's vision is to 'build Dantex into
  the world's most highly regarded provider of
  software for the banking industry'.
• His primary objective is to develop overseas
  sales so that they grow from 30 of total sales
  today to 50 within three years.
• Questions requesting more detail on the specific
  options
• U.S. advertising
• The firm has advertised in the UK in the past,
  with great success
• But current sales to US banks are weak, and the
  software market is very tough in the US
• Sales have weakened because new software from
  rivals is taking market share from Dantex
• New product
• In the past, Dantex has had a high success rate
  with new products
• It already has already identified a gap in the
  market, and believes it knows how to fill it
• Its planned new product will outperform the
  successful rival

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The end!

• So now go back to text book and notes to revise
  the pros and cons of each method .
• You will need this for the exams!!!!