Question 6

Mary thinks that BPs Espresso machine is about to stop working and she has been looking for a suitable replacement. She has identified four potential models and has decided to assess their initial suitability using a multi-criteria analysis (MCA). Mary has identified three key criteria, Cost, Reliability and Speed and assigned weightings of 0.5, 0.3 and 0.2, respectively to these. She then asked several expert baristas for their views on the four chosen models and, based on this, rated each of the four potential suppliers using a four-point rating (with 4 the best and 1 the worst). The decision matrix below summarises this information:

Model	Cost	Reliability	Speed
San Remo	2	1	3
La Spaziale	4	2	1
Expobar	3	3	2
Astoria	1	4	4

1. Which model is preferred based on the information provided? Show your workings.

(6 marks)

BP now asks you to undertake a financial appraisal of the four models, which are considered to be mutually exclusive. The assumption is that they all have a six-year life before they have to be replaced again; assume residual value at the end of that period (Year 6) equivalent to 5% of the initial outlay in each case. As the table below indicates, the initial outlay (in Year 0) required for each model varies in line with the evidence from the MCA and each will yield different levels of cash flows over their six year lives. BP wishes to use an 8% discount rate for the San Remo and Astoria models and a 9% discount rate for the other two models, for which the cashflows appear to be a little riskier. The forecast (net) cash flows of the four models under consideration are as follows:

[Question 6 continues on the next page]

	San Remo	La Spaziale	Expobar	Astoria
Year 0	(4,600)	(3,900)	(4,350)	(5,500)
Year 1	1,200	950	1,150	1,400
Year 2	1,200	950	1,100	1,400
Year 3	900	950	1,100	1,400
Year 4	1,100	1,000	900	1,400
Year 5	900	1,000	900	1,000
Year 6	850	1,000	900	600

2. Calculate the Net Present Value (NPV) for each of the models (use the Present Value table provided on page 12). Which model is preferable according to this technique? Explain your reasoning.

(14 marks)

3. You are told that using a 15% discount rate the NPV of each of the four models is estimated to be:

	San Remo	La Spaziale	Expobar	Astoria
NPV (r=15%)	-503	-136	-339	-614

Use this information to calculate the internal rate of return (IRR) of the four models. Show your workings.

(6 marks)

4. Using the findings above (MCA, NPV and IRR) provide a short report (no more than 150 words) for Mary with your advice on which Espresso model she should choose. Identify the advantages and disadvantages of the three techniques.

(9 marks)