Edexcel A-Level Accounting: Project appraisal (YAC11) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – examination boards hold copyright in their own papers. Use these alongside the official past papers from your board or school.

These questions cover topic 2.6, Project appraisal (outcomes 2.6.1 and 2.6.2), of the Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting specification (XAC11/YAC11), Issue 2, September 2018. Because project appraisal belongs to Unit 2 (Corporate and Management Accounting), everything here is Unit 2 (A2) only; the specification lists Unit 2 as available in January, June and October. The specification allows calculators in its examinations. All businesses and figures are invented.

Links: study guide, revision notes, course hub, checklist, free diagnostics. Show all workings and use discount factors exactly as printed.

Questions

1. State two reasons why £1 received today is worth more than £1 received in three years’ time. [2]

2. Brantwell Signs Ltd is considering a vinyl cutter costing £154,000, expected to bring in £42,000 net cash every year for six years. Calculate the payback period in years and months. [2]

3. Ostrander Castings plc is financed as follows.

Source	Amount (£)	Cost
Ordinary shares and reserves	1,200,000	14%
7% preference shares	300,000	7%
9% debentures	500,000	9%

Calculate the weighted average cost of capital. [4]

4. Hollinsey Joinery is considering a spray booth costing £84,000. It will last four years and then be sold for £12,000. Depreciation is straight-line. Total net cash inflows over the four years, not including the sale proceeds, are expected to be £116,000.

(a) Calculate the average rate of return on the initial investment. [2] (b) Calculate the average rate of return on the average investment. [2]

5. Cragsby Print Ltd is considering a binding machine costing £95,000. Expected net cash inflows are: year 1 £20,000; year 2 £35,000; year 3 £30,000; year 4 £25,000; year 5 £15,000. Calculate the payback period to the nearest month. [3]

6. Kilnhurst Glassworks Ltd is considering a new furnace costing £176,000. Its cost of capital is 12%. Expected net cash inflows and discount factors are:

Year	1	2	3	4
Net cash inflow (£)	50,000	65,000	70,000	40,000
Factor at 12%	0.893	0.797	0.712	0.636

(a) Calculate the net present value. [5] (b) State, with a reason, whether the furnace should be bought on financial grounds. [1]

7. Vardell Foods plc has £200,000 available for investment this year. It is considering three independent projects. None can be partly undertaken.

Project	Initial investment (£)	NPV (£)
A	200,000	30,000
B	120,000	24,000
C	80,000	20,000

(a) Calculate the profitability index (present value of future inflows ÷ initial investment) for each project. [3] (b) Recommend which project or projects Vardell Foods plc should undertake. Justify your answer with figures. [2]

8. Ellerbank Ltd has calculated that a project has an NPV of +£14,200 at a discount rate of 8% and an NPV of −£5,400 at 15%. Its weighted average cost of capital is 12%.

(a) Calculate the internal rate of return to one decimal place. [3] (b) State whether the project should be accepted. [1]

9. Explain two limitations of the payback period as a method of project appraisal. [4]

10. Tarrowfield Bottling plc must choose one of two bottling lines, X or Y. Each costs £150,000 now and lasts four years with no residual value. The cost of capital is 9%.

Year	1	2	3	4
Line X net cash inflow (£)	30,000	50,000	70,000	60,000
Line Y net cash inflow (£)	70,000	55,000	40,000	20,000
Factor at 9%	0.917	0.842	0.772	0.708

(a) Calculate the payback period of each line. [4] (b) Calculate the net present value of each line. [6] (c) Recommend which line the company should buy. [2]

11. Corriebeg Cold Store Ltd is financed by ordinary shares and reserves of £500,000, with a cost of 10%, and a bank loan of £500,000, with a cost of 4%. It is considering a blast freezer costing £66,000. Net cash inflows are expected to be £15,000, £18,000, £20,000, £16,000 and £8,000 in years 1 to 5. The freezer can be sold for £4,000 at the end of year 5.

Year	1	2	3	4	5
Factor at 5%	0.952	0.907	0.864	0.823	0.784
Factor at 7%	0.935	0.873	0.816	0.763	0.713
Factor at 9%	0.917	0.842	0.772	0.708	0.650

(a) Calculate the weighted average cost of capital. [2] (b) Using the weighted average cost of capital as the discount rate, calculate the net present value of the freezer. [4] (c) Calculate the profitability index to two decimal places. [1] (d) Evaluate whether Corriebeg Cold Store Ltd should buy the freezer. [3]

Answers

1. Money received now can be invested to earn interest [1]. Inflation reduces what future money will buy (or: a future receipt may never arrive) [1]. [2] Examiner insight: “State” needs two distinct reasons; inflation and risk run together may be read as one point, so give each its own sentence.

2. 154,000 ÷ 42,000 = 3.67 years [1]. After 3 years £28,000 is unrecovered; 28,000 ÷ 42,000 × 12 = 8 months, so 3 years 8 months [1]. [2] Examiner insight: “3.67 years” does not answer “years and months”, and “3 years 6.7 months” misreads the decimal; convert the unrecovered fraction × 12.

3. Total finance = £2,000,000. Ordinary: 1,200,000 ÷ 2,000,000 × 14% = 8.4% [1]. Preference: 300,000 ÷ 2,000,000 × 7% = 1.05% [1]. Debentures: 500,000 ÷ 2,000,000 × 9% = 2.25% [1]. WACC = 8.4 + 1.05 + 2.25 = 11.7% [1]. [4] Examiner insight: the simple average of 14%, 7% and 9% (10%) ignores the weights and is wrong; show each weighted cost on its own line so your method is visible even if one product slips.

4. (a) Total depreciation = 84,000 − 12,000 = 72,000; total profit = 116,000 − 72,000 = 44,000; average annual profit = 44,000 ÷ 4 = £11,000 [1]. ARR = 11,000 ÷ 84,000 × 100 = 13.1% [1]. (b) Average investment = (84,000 + 12,000) ÷ 2 = £48,000 [1]. ARR = 11,000 ÷ 48,000 × 100 = 22.9% [1]. [4] Examiner insight: ARR uses profit, so deduct depreciation; average cash inflow (£29,000) ÷ investment is not ARR.

5. Cumulative cash flow: −75,000 (year 1), −40,000 (year 2), −10,000 (year 3) [1]. Part of year 4: 10,000 ÷ 25,000 × 12 = 4.8 months [1]. Payback = 3 years 5 months [1]. [3] Examiner insight: the months come from the £10,000 still outstanding at the start of year 4, not from the year 4 inflow alone; show the cumulative column.

6. (a) Year 1: 50,000 × 0.893 = 44,650 [1]. Year 2: 65,000 × 0.797 = 51,805 [1]. Year 3: 70,000 × 0.712 = 49,840 [1]. Year 4: 40,000 × 0.636 = 25,440 [1]. Total PV = 171,735; NPV = 171,735 − 176,000 = −£4,265 (negative) [1]. (b) Do not buy: the NPV is negative, so the furnace earns less than the 12% cost of capital [1]. [6] Examiner insight: show the negative sign or brackets on the NPV, and make the decision in (b) follow from your own figure in (a) with the reason stated, not just “reject”.

7. (a) PV of inflows = investment + NPV. A: 230,000 ÷ 200,000 = 1.15 [1]. B: 144,000 ÷ 120,000 = 1.20 [1]. C: 100,000 ÷ 80,000 = 1.25 [1]. (b) Rank by PI: C then B, total investment 80,000 + 120,000 = £200,000 and combined NPV £44,000 [1]. This beats project A alone (NPV £30,000), so undertake B and C [1]. [5] Examiner insight: follow the PI definition the question states; NPV ÷ investment (0.15, 0.20, 0.25) is a different measure.

8. (a) IRR = 8 + [14,200 ÷ (14,200 + 5,400)] × (15 − 8) [1] = 8 + 0.7245 × 7 = 8 + 5.07 [1] = 13.1% [1]. (b) Accept: 13.1% is above the WACC of 12% [1]. [4] Examiner insight: the denominator is 19,600, the gap between the NPVs; 14,200 − 5,400 gives a rate above 15%, outside the range tested, which signals an error.

9. Inflows arriving once the outlay is recovered are not counted [1], so a project that keeps earning for years may lose out to one that recovers its cost quickly and then stops [1]. Each pound counts equally whatever year it arrives in, so the time value of money is ignored [1], and two projects with the same payback can have very different present values [1]. [4] Examiner insight: “Explain” needs each limitation linked to its consequence; four undeveloped limitations are worth less than two developed ones.

10. (a) Line X cumulative: −120,000, −70,000, 0 at end of year 3 [1]; payback 3 years exactly [1]. Line Y cumulative: −80,000, −25,000 at end of year 2 [1]; 25,000 ÷ 40,000 × 12 = 7.5 months, payback 2 years 7.5 months (2 years 8 months to the nearest month) [1]. (b) Line X PVs: 27,510; 42,100; 54,040; 42,480 [1]. Total 166,130 [1]. NPV = +£16,130 [1]. Line Y PVs: 64,190; 46,310; 30,880; 14,160 [1]. Total 155,540 [1]. NPV = +£5,540 [1]. (c) Buy line X: its NPV is £10,590 higher, so it adds more value, although Y pays back about 4.5 months sooner [1]. Prefer Y only if cash is very tight or X’s later inflows are unreliable [1]. [12] Examiner insight: use your own figures and say why one method outweighs the other here; “X has a higher NPV” alone is not a justified choice.

11. (a) Ordinary: 0.5 × 10% = 5%; loan: 0.5 × 4% = 2% [1]. WACC = 7% [1]. (b) Year 5 cash flow = 8,000 + 4,000 = 12,000 [1]. PVs at 7%: 14,025; 15,714; 16,320; 12,208; 8,556 [1]. Total 66,823 [1]. NPV = 66,823 − 66,000 = +£823 [1]. (c) PI = 66,823 ÷ 66,000 = 1.01 [1]. (d) NPV is positive and PI is above 1, so the freezer just meets the 7% required return [1]. The margin is thin: a fall of about £1,150 in the year 5 cash flow would make the NPV negative, so the forecasts must be reliable [1]. Non-financial factors such as food safety and energy use could tip the balance; buy if they support it, for example if the old freezer risks failing [1]. [10] Examiner insight: for “evaluate”, weigh the thin NPV against the risks and finish with a clear buy or do-not-buy judgement; in (b), name the factor row you used.

Where marks are usually lost

• Choosing a discount row that does not match the WACC you calculated.
• Leaving the residual value out of the final year, as in question 11.
• Getting the IRR denominator wrong, so the answer falls outside the two rates used.
• Forgetting to charge depreciation in ARR, or not stating the investment base.
• Converting 0.8 years to 8 months instead of 9.6 months.

Next steps

• Revision notes for project appraisal
• Study guide for project appraisal
• Edexcel A-Level Accounting hub
• Printable checklist
• All free 10-minute diagnostics
• Book a free trial class

Official syllabus

Pearson Edexcel International Advanced Subsidiary/Advanced Level in Accounting (XAC11/YAC11) specification, Issue 2, September 2018, first teaching September 2015 (Pearson Education Limited): Unit 2, topic 2.6 Project appraisal, outcomes 2.6.1 and 2.6.2.