PAST PAPER QUESTION

Mrs Glam wants to expand her clothes shop. Mrs Glam has commissioned a market research
company at a cost of $3,000 to research her options for her. The company have offered two
options:
Option 1
Remain in her the current premises and undertake an advertising campaign at a cost of
$2,000 to increase the profile of the shop in the area. It is estimated that revenue will
increase by 10% from its current level of $50,000 per year. The contribution earned on
revenue is 30%.
Option 2
Move the shop to a more central location and undertake an advertising campaign to both
increase the profile and the move to new premises. This more extensive campaign would
cost $4,000 but revenue would be expected to increase by 18% from its current level. The
level of contribution earned on revenue is not expected to change.
There would be further costs involved in moving location which have been estimated:
? Moving costs are estimated to be $1,500. This includes the cost of refitting the shop,
and would be payable immediately
? New shop fittings will be required costing $2,500. These will be depreciated on a
straight line basis.
? Rates of $4,000 will be payable yearly in advance. This cost is 15% higher than
Mrs Glam currently pays, due to the location.
Other information
? Mrs Glam uses a cost of capital of 10%
? The expansion is to have a life of 4 years.
Required:
(a) State if the following items relating to Mrs Glam’s decision how to expand are
relevant or irrelevant cash flows in a net present value calculation:
(i) The $3,000 market research fee (1 mark)
(ii) Depreciation of $625 per year for the new shop fittings. (1 mark)
(iii) The costs of $1,500 incurred in moving to the new premises. (1 mark)
(b) Calculate the present value of the INCREMENTAL contribution cash flow that will
arise if option 2 is compared to option 1. (2.5 marks)
(c) Calculate the present value of the cash flowsrelating to the INCREMENTAL ratesthat
will arise if option 2 is compared to option 1.

HI SIR I AM UNABLE TO SOLVE B AND C KINDLY EXPLAIN ME HOW TO SOLVE IT