Refer to Appendix 2. Calculate: (i) payback period

Mark scheme

Marking points from the official mark scheme (May/June 2017). The mark or mark type is shown in brackets.

1. [2] 4.25 years or 4 years 3 months
2. [1] Some attempt e.g. cumulative net cash flows
3. [3] Net cash flows / years as % = (2.3-2)/5 × 100 = 0.3/5 × 100 = 6% (or 0.06)
4. or
5. Average annual net cash flow – annual depreciation/initial cost as % = (0.46 -0.4) = 0.06 / 2 × 100 = 3% (or 0.03)
6. or
7. Sum of Net cash flow each year - average depreciation/initial cost as % = 0.1 + 0.1 + 0.1 + 0 + 0 = 0.3 / 2 × 100 = 15% (or 0.15)
8. [2] Some attempt with partially complete correct working
9. [1] Some attempt / correct formula
10. [2] NPV = -0.235m (accept –0.24m or –$0.23m)
11. [1] Sum DCF over 5 years = $1.765m (accept $1.77m or $1.76m)
12. [1] Some reasonable attempt e.g.mistake in calculation
13. $m not required
14. [2] Just over 6 years / 6.054 years (accept 6 years)
15. [1] Use of DCF or some reasonable attempt e.g. 6.647yrs
16. Examiner Note: Example of Full Calculation (details not required for 2 marks): NPV over 5 years + DCF in year 6 = -$0.235 + (0.56 × $0.4m) = -$0.011m; Therefore NPV reaches zero in just over 6 years; Year 7 DCF for whole year: 0.51 × $0.4m = $0.204m; So, Year 7 DCF per day: $0.204m / 365 = 0.00056; Therefore, answer is 6 years + (0.011 / 0.00056) = 6 years 20 days. (6yrs 0.647mths)
17. Note to examiners: Own figure rule from 4(a) and 4(b) applies L1 AN and EVAL if only use results or only use other information.
18. Answers could include:
19. Initial investment cost: Yr 0 (2), Yr 1 0.5, Yr 2 0.5, Yr 3 0.5, Yr 4 0.4, Yr 5 0.4, Yr 6 0.4, Yr 7 0.4
20. Discount factor at 10%: Yr 0 1, Yr 1 0.91, Yr 2 0.83, Yr 3 0.75, Yr 4 0.68, Yr 5 0.62, Yr 6 0.56, Yr 7 0.51
21. Net cash flow discounted at 10% $m: Yr 0 (-2), Yr 1 0.455, Yr 2 0.415, Yr 3 0.375, Yr 4 0.272, Yr 5 0.248, Yr 6 0.226, Yr 7 0.205
22. Use of results from (a).
23. Assume lifetime of investment accurate and the forecast cash flows are reliable and the choice of discount factor is reliable:
24. Payback indicates go ahead as money recovered in lifetime.
25. Discounted payback should not go ahead as money recovered outside lifetime.
26. ARR - less than discount factor so not go ahead.
27. NPV - not go ahead as NPV is minus.
28. BUT
29. All figures are forecast and may be better than expected.
30. Discounted payback and NPV show that 6 years is the time when investment is repaid - only one year longer than expected lifetime.
31. Expected lifetime is a very conservative estimate – current machinery is 14 years old and expected life in the industry is ten years.
32. These point to going ahead with investment.
33. Other things to consider are:
34. The risks associated with the forecasting of the cash flows.
35. the speed with which the existing machinery will deteriorate.
36. the importance of new machinery in the strategy to reduce costs and increase quality.
37. the availability of finance – there is money for the marketing options so this may not be a problem but Pedro does have to obtain finance.
38. Application
39. Use made of answers from 4(a)
40. Reference to 10 year expected life
41. Evaluation
42. A supported recommendation should follow consideration of pros and cons of making the investment.
43. Points made re adequacy / inadequacy / reliability of methods from 2 (a)
44. Assessment of importance of other information e.g. possible future market conditions, economic factors, government actions, availability and cost of finance, other planned changes by PV.