1
April2021
MARK SCHEME (TOTAL: 40 MARKS)
Question 1 (25 Marks):
Two friends Alison and Emdad have started a Coffee shop named EMDALISON CAFÉ.
The Café sells Coffee, homemade Cupcakes and freshly made Orange Juice.
Coffee, Cupcakes and Orange Juice are sold in cups (units).
EMDALISON CAFÉ is currently working at full capacity.
Alison & Emdad are looking at investing in a new Italian coffee maker that will make
coffee faster. The coffee maker costs £1,500 with an expected useful life of 5 years and
scrap value of £200. All of their sales and expenses are paid by cash.
Incremental Cash Flow for the 5-year period for the machine are estimated as
follows:
2022
£
550
Additional information:
April 2021
2023
£
550
2024
£
450
2025
£
300
2026
£
150
2


Depreciation is charged using the straight line method
EMDALISON CAFÉ has a cost of capital of 10%
Present value table:
Year
1
2
3
4
5

1a)
Discount rate %
10%
0.91
0.83
0.75
0.68
0.62
EMDALISON CAFÉ requires a payback period of 3 years.
Calculate the Net Present Value (NPV) for the machine.
Please show your workings clearly
Years
Start of 2022
End of 2022
End of 2023
End of 2024
End of 2025
End of 2026
End of 2026
NPV
1b)
Cash Flow Discount
factor
(1,500)
1.00
550
0.91
550
0.83
450
0.75
300
0.68
150
0.62
200
0.62
(10 marks)
PV
(1,500)
500.5
456.5
337.5
204
93
124
215.5
1 Mark
1 Mark
1 Mark
1 Mark
1 Mark
1 Mark
1 Mark
3 Marks
Calculate the Payback Period for the machine.
Please show your workings clearly
(3 marks)
2 Years+400/450 X12 Months=2 Years + 10.66 Months~11 Months
OFR 1.5 Marks ….If not round up then 2 marks
1c)
ADVISE Alison & Emdad whether they should proceed with purchasing the coffee
maker or not. You can refer to any other non-financial factors that might influence
the decision.
You should refer to your calculations in 3a) and 3b) in your answer.
(8 marks)
Financial Factor: 5 Marks
April 2021
3
The Pay Back period is 2 years and 11 months which is within the target payback period as
the management of EMDALISON CAFÉ requires a payback period of 3 years. NPV is also
positive 215.5 which means Present Value of all inflows are greater than Present Value of
the Cash Outflow. Alison & Emdad are advised to proceed with purchasing the machine.
Non Financial Factor: 3 Marks
Internal Process: Efficient process.
Learning & Growth: Employees might require training.
These are only forecasted/estimated cash flows. Actual cash flows might be
different considering various internal & external factors.
No mark is awarded for simply mentioning the points in the essay questions. To get
full marks, a student needs to explain the points along with application linking to the
business.
3d)
DESCRIBE ONE OTHER investment appraisal technique and explain how it can be
useful in assessing long-term investment proposals.
(4 marks)
Accounting Rate of Return (ARR)
Yearly Depreciation= (1,500-200)/5=£260
Operating Profit
Year 2022: 550-260= 290
Year 2023: 550-260=290
Year 2024: 450-260=190
Year 2025: 300-260=40
Year 2026: 150-260= (110)
Average Operating Profit=700/5=£140
ARR= 140/ (1,500+200)/2=140/850 X 100%= 16.47%
Full Marks can be given for ARR based on initial investment or average investment
ARR measures the average annual profit for a project expressed as a percentage return
on the average funds invested in the project. However ARR has got some limitations. ARR
disregards Time Value of Money. Also ARR considers accounting profits and accounting
profits are influenced by judgements such as choice of depreciation rates and methods
whereas cash flows are not influenced by such decisions.
2 Marks for calculation and 2 marks for description and analysis.
April 2021
4
Question 2 (15 Marks):
Alison and Emdad have performed a market research. On the basis of that they estimate
the following:
Coffee: Elastic Demand
Cup Cakes: Inelastic Demand
2a) Which strategy (Price-Skimming Strategy OR Penetrating Pricing Strategy) is
suitable for Coffee and Cupcakes? EXPLAIN
(5 marks)
Price Skimming Strategy is often used where prices are inelastic, setting prices high to
take advantage of customers’ insensitivity to prices. (1.5 Marks)
So for Cup Cakes, appropriate strategy might be Price Skimming Strategy. (1 Mark)
Penetrating Price Strategy is often used where prices are elastic, setting prices low to take
advantage of customers being sensitive to prices. (1.5 Marks)
So for Coffee, appropriate strategy might be Penetrating Price Strategy. (1 Mark)
2b) EMDALISON CAFÉ is busy most of the year with full capacity, but during the month of
September there is not enough demand to keep the Coffee shop operating to its full
capacity. Sue, a friend of Alison, offered her with a ONE-OFF deal for the home made
Cupcakes during the month of September. Her offer is as follows
ONE-OFF deal
1,000
REGULAR Selling price per unit (£)
1.00
ONE-OFF deal Selling price per unit (£) 0.60
Variable cost per unit (£)
0.50
Annual fixed costs (£)
2,400
The Finance Manager Kate has advised that they can accept this special offer in SHORT
TERM and NOT in LONG TERM.
EXPLAIN the reasons for this advice given by the Finance Manager.
(10 marks)
April 2021
5
EMDALISON CAFÉ can accept the order as it will be using up spare capacity in the shop.
The Fixed Costs will be incurred any way as it can’t be avoided (1 mark). So any
Contribution EMDALISON CAFÉ can generate from selling additional Cup Cakes will
increase its profits (1 mark). This special order will make a positive Contribution towards
covering the Fixed costs. (1 mark)
ONE-OFF deal
£
1,000
ONE-OFF deal Selling price per unit
Variable cost per unit
0.60
0.50
Contribution per unit
Total Contribution
0.10
100
(3 marks)
It can be very tempting to bid for extra business by reducing prices for the special offers. In
the Short term it will boost profit. However, in the Long term, this may be misguided strategy
(1 mark). If EMDALISON CAFÉ keeps on accepting special offer continuously at a reduced
price just to cover the Variable costs (1 mark), the shop will not make sufficient contribution
to cover its Fixed overhead costs (1 mark) and might lead to the Cost Spiral and damage
the profitability of the company in the Long term. (1 mark)
April 2021