SECTION A: Compulsory. Answer all questions in this section
Baker’s Pantry (BP) is a small artisanal bakery and café in Padstow, owned and run by two sisters Mary and Shelley. The business had been doing well, pre-pandemic, and has just about managed to survive by offering take-away, click and collect and delivery services. The owners now want to look to the future and need to decide which one of these services to maintain once trading gets back to normal again in the summer when their hands are full running the café. Mary has put together the following payoff matrix which looks at the revenues from each service over the next four months under different summer weather forecasts.
Option Poor Reasonable Good
Take Away £4,000 £11,000 £22,000
Click and Collect £8,000 £14,000 £18,000
Delivery £25,000 £17,000 £5,000
⦁ Identify the preferred option for BP according to the (i) maximin and (ii) maximax criteria, highlighting what attitude to risk each represents.
⦁ Explain to Mary and Shelley, how they could transform this decision from one of uncertainty to one of risk.
(Total: 10 marks)
Mary and Shelley have plans for expanding the café by adding an outside dining area. They have been given costed designs by two local firms: Smith and Jones. These differ in terms of initial cost and the pattern of cashflows, as shown in the table below, with the Smith design offering higher capacity, but costing more (all cashflows are in £ thousands).
Design Initial Outlay (Year 0) Year 1 Year 2 Year 3 Year 4 Year 5 Year 6
Smith (85) 15 25 40 35 35 35
Jones (50) 10 15 20 25 30 35
⦁ Calculate the payback period for each of these projects. Which are acceptable if BP requires a payback of the initial investment within four years and which would you advise Mary and Shelley to choose?
⦁ A recent survey suggested that, despite its shortcomings, almost one-third of UK firms still used the payback period as the primary appraisal technique for expansion decisions. What advantages does the payback period have compared to other investment appraisal methods?
(Total: 10 marks)
Baker’s Pantry is thinking about branching out into baking cakes for special occasions. They have calculated the direct material costs (largely ingredients) could be anywhere between £5 and £8, depending on the supplier used; they have estimated that each cake will require two hours of labour time, but the cost per hour they will have to pay can vary between £8 and £11, depending on the amount of prior experience of the worker. Mary and Shelley have put together the following probability distributions for the two cost components. Assume that these are the only costs and that the proposed selling price for the cake is £35.
Direct Materials (per unit) Probability Direct Labour (per hour) Probability
£5 0.20 £8 0.10
£6 0.30 £9 0.35
£7 0.40 £10 0.25
£8 0.10 £11 0.30
⦁ What is the difference between a sensitivity analysis and a scenario analysis?
⦁ Calculate the profit contribution per cake under the following scenarios: ‘base case’, ‘best case’ and ‘worst case’.
(Total: 10 marks)
[END OF SECTION A]
[SECTION B STARTS ON THE NEXT PAGE]
SECTION B: Answer only TWO questions from this section.
Mary and Shelley are looking at possible locations in Cornwall for a second café. They have identified four possible locations: Falmouth, Penzance, St Ives and Bodmin. The first-year profits generated by the café in each location is heavily dependent on the volume of tourists visiting Cornwall in the summer months. Falmouth and St Ives benefit most from a large influx of tourists, while Penzance and Bodmin have larger resident populations, so are not as reliant on tourism. The payoff matrix below shows annual profits (in £ thousands) under four level of tourists (Low, Medium, High).
Tourist Numbers (resulting profits)
Location Low Medium High
Falmouth 45 140 200
Penzance 100 100 150
St Ives 30 110 260
Bodmin 120 120 130
⦁ Construct a potential regret matrix and use it to determine the best location according to the minimax regret criterion. What attitude to risk does this represent?
⦁ BP has managed to derive probabilities of the likelihood of different levels of tourist numbers by using historical data from the Cornish Tourist Board. This suggests the following probability distribution: Low (35%), Medium (30%), High (35%). What location represents the risk neutral decision for the company?
⦁ Mary is not happy to base the decision about the location of the second café on historical data and has asked a local research group to generate more accurate forecasts of tourist numbers. What is the maximum that BP should pay for information that tells it with absolute certainty the number of tourists visiting Cornwall in the summer?
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