Solar Soccer Academy Ltd.
(SSA)
Solar Soccer Academy Ltd. (SSA) is a private limited company set up five years ago by
Stephen Murdock. It provides top-quality soccer (football) skills and technique coaching.
So far, SSA has been a success, and Stephen is deciding whether to open another
academy in a neighbouring city.
The cost of building a second academy is $500 000. Stephen has produced forecasted
financial information for the second academy’s first five years of operation (see Table
1).
Table 1: Forecasted financial information for a second academy
Stephen estimates cash outflow to be 25 % of the total cash inflow in years 1, 2 and 3
and 20 % of the total cash inflow in years 4 and 5.
(b.i)
Using Table 1 and other information provided, calculate for SSA’s second academy, the
payback period (show all your working).
[2]
Markscheme
Payback between years 3 and 4.
$300 000/12 = $25 000/month
$50 000/$25 000 = 2
Payback is 3 years 2 months.
(or 2 years 7 months, 2.58333 or 2.58 years or 31 months if only cash inflows used)
Alternative working: $120 000 + $150 000 + $180 000 + ($50 000/$300 000) × 12
= 3 years 2 months
Alternative working: = $120 000 + $150 000 + $180 000 + ($50 000/$300 000) =
3.1666 or 3.17 years (allow rounding) or 38 months
Award marks as follows:
[1] If a candidate who has shown working provides a correct procedure (thus,
demonstrates an understanding of the underlying concepts) but has made an error in
calculation or the answer does not include years/months.
[1] If a candidate does not show any working and simply writes the answer.
[2] if a candidate provides the correct answer with working. A correct answer must
include years/months.
N.B. award a maximum of [1] if net cash inflows used.
Examiners report
This three-part question suited the more mathematically minded. However, a large
majority of candidates failed to notice that it was "net" cash flows that were required for
the calculations. Candidate own figure rule (OFR) was applied in parts (ii) and (iii)
allowing full marks with OFR if the working and alternative OFR answers were correct.
Still, a sizeable minority continue to lose marks by not adding the correct value signs eg.
$ or %.
(b.ii)
Using Table 1 and other information provided, calculate for SSA’s second academy, the
average rate of return (ARR) for the first five years of operation (show all your working).
[2]
Markscheme
Total returns = $120 000 + $150 000 + $180 000 + $300 000 + $560 000 = $1 310 000
Capital Cost = $500 000
Years of use = 5
ARR = (total returns - capital cost) / years of use capital cost×100
Total return over 5 years = $1 310 000 - capital cost = $810 000
Average annual profit = $810 000 / 5 = $162 000
ARR = ($162 000 / $500 000) ×100 % = 32.4 %
(Accept 47 % if only cash inflows used)
Award marks as follows:
[1] if a candidate who has shown working provides a correct procedure (thus,
demonstrates an understanding of the underlying concepts) but has made an error in
calculation or the answer does not include the percentage sign (%).
[1] if a candidate does not show any working and simply writes the answer.
[2] if a candidate provides the correct answer with working. A correct answer must
include the percentage sign (%).
Award no marks [0] merely for writing the formula.
Apply candidate own figure rule (OFR) if candidate uses an incorrect net cash flow
figure from (b)(i).
(b.iii)
Using Table 1 and other information provided, calculate for SSA’s second academy, the
net present value (NPV) at a discount rate of 4 % (see Table 2) (show all your working).
Table 2: Discount rates
[2]
Markscheme
Using discount tables:
Year 1 $120 000 × 0.9615 = $115 380
Year 2 $150 000 × 0.9246 = $138 690
Year 3 $180 000 × 0.8890 = $160 020
Year 4 $300 000 × 0.8548 = $256 440
Year 5 $560 000 × 0.8219 = $460 264
Total present value = $1 130 794
Net present value (NPV) = TPV - capital cost
NPV = $1 130 794 − $500 000 = $630 794
(accept $948 000 if only cash inflows used)
Some candidates may add the $500 000 as Year 0 and calculate it this way. Please
award full marks if the correct answer is arrived at.
Full headings and full calculations are not expected for each year.
Full marks can be awarded if there is some evidence of calculation especially the
movement from the total DCF to NPV, if the DCF for each year is not shown but it is
clear the candidate understands the method.
N.B. allow the candidate own figure rule (OFR) if using incorrect net cashflow from (b)
(i).
Award [2] if a candidate provides the correct answer with working. A correct answer
must include $ sign. Award [1] for working and [1] for the correct answer.
Award [1] If a candidate who has shown working provides a correct procedure (thus,
demonstrates an understanding of the underlying concepts) but has made an error in
calculation or the answer does not include $ sign.
Award [1] If a candidate does not show any working and simply writes the answer.
Award no marks [0] for writing the formula.
(c)
Explain one disadvantage for SSA of only using the payback period method in making
its decision to open a second academy.
[2]
Markscheme
only focuses on how fast it will payback rather than overall profit as the most
important factor. Overall ARR is 32.4 %, a very high return;
using the payback method can encourage short-termism as it does not look at
the net cash flow made after it has paid back. Student numbers significantly
increase after the payback period but this is not accounted for;
this new soccer academy seems like a long-term investment, is payback
suitable?
fails to consider the time value of money especially if interest rates change
over the 5 years of cash flows being considered.
Accept any other relevant disadvantage and explanation.
This question is about a limitation of the payback method so do not credit either all the
figures are forecasted, or this method does not take non-financial factors into account.
This is true of all investment appraisal methods.
Award [1] for a relevant and correct disadvantage identified.
Award [1] for a relevant and correct explanation with application to SSA, up to a
maximum of [2].
