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Using the data in Extracts E to H, Payback and NPV investment appraisal methods, evaluate Plan A and Plan B expansion plans and recommend which one might be better for Northfield Cycles - Edexcel - A-Level Business - Question 2 - 2022 - Paper 3
Question 2
Using the data in Extracts E to H, Payback and NPV investment appraisal methods, evaluate Plan A and Plan B expansion plans and recommend which one might be better f... show full transcript
Worked Solution & Example Answer:Using the data in Extracts E to H, Payback and NPV investment appraisal methods, evaluate Plan A and Plan B expansion plans and recommend which one might be better for Northfield Cycles - Edexcel - A-Level Business - Question 2 - 2022 - Paper 3
Step 1
Evaluate Plan A using NPV and Payback methods
Answer
To evaluate Plan A, we first calculate its Payback Period. The cash flows are:
- Year 1: -£12,000
- Year 2: £5,000
- Year 3: £4,000
- Year 4: £15,000
- Year 5: £20,000
- Year 6: £5,000
- Year 7: £5,000
To find out when the initial investment of £40,000 is recovered:
- After Year 1: -£12,000
- After Year 2: -£7,000
- After Year 3: -£3,000
- After Year 4: £12,000 (recovered)
Thus, the Payback Period is approximately 4 years.
Next, we calculate the NPV which is given as £4,989 at a 10% discount rate.
Step 2
Evaluate Plan B using NPV and Payback methods
Answer
Similarly, for Plan B, the cash flows are as follows:
- Year 1: -£60,000
- Year 2: £2,000
- Year 3: £12,000
- Year 4: £20,000
- Year 5: £20,000
- Year 6: £5,000
- Year 7: £28,000
Calculating the Payback, we observe:
- After Year 1: -£60,000
- After Year 2: -£58,000
- After Year 3: -£46,000
- After Year 4: -£26,000
- After Year 5: -£6,000
- After Year 6: -£1,000
- By Year 7, it suggest we recover the investment but it takes longer than 7 years.
NPV calculation needs to be similar but based on these cash flows, and it might give a negative value, considering higher costs of the plan.
Step 3
Recommendation based on analysis
Answer
Considering both plans, Plan A has a feasible payback period of about 4 years and a positive NPV, making it a more viable option financially when compared to Plan B, which takes significantly longer to break even and the risks and costs appear to outweigh the benefits. Therefore, I recommend that Northfield Cycles proceed with Plan A for expansion.