Q7. (12 marks) The Costa Coffee Company (for short CCC) is anticipating a major expansion of its franchised coffee outlets into Europe and African countries. The investment opportunities available to the company involve rates of return and initial investment amounts that differ because of differences in operating costs and consumer demand in the countries involved. The total investment (M) that CCC can undertake is constrained by the cost of capital (k), which is defined by the following investment supply function:

k = 6 + 0.8 M

The initial investment and rate of return for each country (i.e. the investment demand schedule) is listed below in order of decreasing rate of return.

Country Initial Investment (M) ($ million) Internal Rate of Return (IRR) %

South Africa 3.8 16%

Kenya 1.3 15%

France 2.4 13%

Germany 3.1 11%

Ethiopia 1.9 9%

A.Plot the investment supply function and the investment demand schedule on the graph below.

B.Determine the optimal level of investment and the corresponding cost of capital for the firm. Also indicate the countries in which CCC should invest.