Investment Appraisal [40 marks]

1. [Maximum mark: 10] 23M.2.SL.TZ1.2

Windmills OPQ (WO)

Windmills OPQ (WO) develops and produces electrical and mechanical components
for windmills. WO has developed a unique selling point/proposition (USP)
because of its customization and modification services.

In 2023, WO identified two six-year investment project

options that could be beneficial.

Option 1: Research and development (R&D).

Option 2: Open a wind farm with five windmills.

[Source: Wind turbines, Carno Wind Farm. Image by Philip Halling.

https://commons.wikimedia.org/wiki/File:Wind_ turbines,_Carno_Wind_Farm_-_geograph.org.uk_-
_1909021.jpg. Under copyright and licensed under the Creative Commons Attribution-ShareAlike 2.0
Generic (CC BY-SA 2.0). https://creativecommons.org/licenses/bysa/2.0/deed.en.]

The capital costs and forecasted cash flows for both investment projects are
shown in Table 2.

Table 2: Capital costs and expected cash flows for both investment projects
(all figures in $000s)
WO’s board of directors think that the forecasted cash flow for Option 2 is too low.
They believe that the demand for electricity generated by windmills is likely to
rise more than the current forecast assumes. Electricity prices are also increasing.
(a) Define the term unique selling point/proposition (USP). [2]

(b) Using relevant information from Table 2, calculate:

(b.i) the average rate of return (ARR) for Option 1 (show all your working); [2]

(b.ii) the average rate of return (ARR) for Option 2 (show all your working); [2]

(b.iii) the payback period for Option 1 (show all your working). [2]

(c) Comment on whether WO should choose Option 1 or Option 2. [2]

2. [Maximum mark: 20] 21M.2.SL.TZ0.4
ReVolve Ltd (RV)

ReVolve Ltd (RV ) manufactures and sells high-quality, high-priced bicycles to high-
income earners. Operating in a niche market, its advertising slogan and unique
selling point/proposition (USP) is “hand made to order, in the USA, delivered
within seven days”. Brand loyalty is strong, but brand recognition outside of its
customer base is weak. 98 % of its sales are to customers living within 50 miles of
the business.

Prior to 2017, RV received an increasing number of customer complaints that

phone lines were often engaged and calls not returned. As such, it adopted e-
commerce. Its website now allows customers to:

customize their choice of bicycle

place orders
pay for purchases
have their questions answered.

RV employs 20 highly paid, skilled employees using job production. To retain

these workers, RV has raised their wages significantly since 2016.

Increasing competition from imports of hand-made high-quality bikes has

forced down prices in this niche market. RV has been making increasingly larger
losses since 2017. In 2020, its sales fell by 15 %. Inflation is forecasted at between
2 % and 3 % for the next three years. As such, RV’s directors are considering two
options to enable it to lower the prices of its bicycles.

Option 1: Offshore production to China, where production costs are significantly

lower. The bicycles would be manufactured using batch production. RV would
focus only on the design and marketing of its bicycles.

Option 2: Invest in new job production techniques that enable parts to be glued
rather than welded, which only requires unskilled labour. Investment would cost
$3 500 000 and the forecasted annual net cash flow is $600 000.
[Source: [Bicycle] Hall, E., (2006). My new bicycle [online]. Available at
https://www.flickr.com/photos/mulegirl/99132433 (CC BY-SA 2.0)
https://creativecommons.org/licenses/by-sa/2.0/ [Accessed 29 August 2019].]
(a) Define the term niche market. [2]

(b) Explain two benefits to RV of the decision to adopt e-commerce. [4]

(c.i) Calculate the payback period if RV chooses Option 2 (show all your
working). [2]

(c.ii) Explain one disadvantage to RV of using the payback period

method of investment appraisal. [2]

(d) Recommend whether RV ’s directors should choose Option 1 or

Option 2. [10]
3. [Maximum mark: 10] 19N.2.SL.TZ0.2
Daytona Go-Carts

In 2020, Ron James aims to open Daytona Go-Carts, a race track where individuals as
young as twelve can rent go-carts and participate in races. Through primary
market research, Ron has discovered that many teenagers would enjoy
participating in go-cart races.

Ron has two options for locations for the go-cart race track:

Option 1: The cost of the site would be $1.2 million

Option 2: The cost of the site would be $1.8 million.

Forecasted profits for Option 1 are:

Forecasted profits for Option 2 are $300 000 in the first year, with profits growing
by 20 % per year for the next four years.

(a) State two methods of primary market research. [2]

(b.i) Calculate, for Option 1 the average rate of return (ARR) (show all
your working). [2]

(b.ii) Calculate, for Option 1 the payback period (show all your working). [2]

(c) Calculate, for Option 2, the average rate of return (ARR) (show all
your working). [2]

(d) Explain one reason why Option 1 may be a less risky

investment than Option 2. [2]

© International Baccalaureate Organization, 2024