Ben is a retired budget auditor who is currently looking for a new investment opportunity. He is considering two investments: Calzone Zone, a small restaurant specialising in calzone, and Icetown, a skating and curling rink. The projected cash flows of the two investments are shown below.

Ben can only choose one projects, so he asks for your help and advice in reaching a decision on which investment to accept. He tells you he requires a 5% rate of return on his investment.

	Calzone Zone	Icetown
Cash flows	000	000
Initial investment	(885)	(300)
Cash flows year 1	150	215
Cash flows year 2	195	215
Cash flows year 3	200	215
Cash flows year 4	230	215
Cash flows year 5	265	(585)

Assume the initial investment arises at the start of the first year of the project and all the subsequent cash flows occur at the end of the year.

Required:

1. Calculate the net present value of each of the projects. Which project should Ben invest in? Show your workings.

(6 marks)

2. Calculate the internal rate of return of each of the projects. Which project should Ben invest in? Show your workings.

(Tip: You may use the IRR function in spreadsheet software)

(6 marks)

3. Plot the net present value of each of the projects as a function of the required rate of return.

(Tip: Use spreadsheet software to calculate NPV using r of 0% - 100% and create a scatter plot)

(6 marks)

4. Critically evaluate the internal rate of return as a capital investment appraisal tool and discuss the key shortcomings specific to this method.

6 marks)

5. What are the economic factors reflected in the required rate of return? Discuss the likely effects of the economic shock brought by the COVID-19 pandemic on rates of return required by investors.

(6 marks)