| Date | November 2020 | Marks available | 4 | Reference code | 20N.2.SL.TZ0.5 |
| Level | Standard level | Paper | Paper 2 | Time zone | Time zone 0 |
| Command term | Explain | Question number | 5 | Adapted from | N/A |
Question
Pablo’s Peanuts (PP)
Pablo recently emigrated from Argentina to Miami, Florida, which has a large Hispanic* population. However, he could not find caramelized peanuts – known as garrapiñada – at any of the Latin American markets in Miami. These tasty sweet snacks, sold by street vendors, are very popular in Latin American countries. Pablo began testing different recipes to make the snack himself. Once convinced he had the perfect product, he conducted primary market research in several Hispanic neighbourhoods. He was overwhelmed by the positive response.
As a result, Pablo set up Pablo’s Peanuts (PP) as a private limited company. He then purchased a food truck (a large vehicle equipped to cook and sell food). From Tuesday to Sunday, he drove to different Latin American markets in the Miami area to cook and sell his product. PP soon became profitable, but meeting demand was difficult.
Pablo wants PP to grow. To do this, he needs a second food truck and an employee. The second truck would require an investment of $100 000. Pablo’s break-even analysis shows that the expected increased output would more than double PP’s profits if the cost of fuel for the food trucks remains constant.
Pablo is considering two options to finance the second truck:
- Option 1: A local Miami bank, clearly impressed by the break-even analysis data, is willing to lend Pablo $100 000 with a 10 % interest rate.
- Option 2: A business angel, Ana Perez, with a strong portfolio of Latin American food products, has approached Pablo. She is offering $100 000 for 35 % of shares in PP.
Table 4: Financial data related to both options
* Hispanic: relating to Spain or to Spanish-speaking countries, especially those of Central and South America
State two characteristics of a business angel.
Explain two reasons why Pablo conducted primary market research.
Explain one advantage and one disadvantage of using a break-even analysis for PP.
Recommend whether Pablo should choose Option 1 or Option 2.
Markscheme
Features of angel investors include:
- Angel investors provide relatively small amounts of finance to early-stage / start-up companies (new ventures),
- Is an external source of finance,
- The finance is usually in exchange for equity
- Angel investors typically invest in high risk ventures, ones banks are unlikely to lend to.
- Angel investors typically participate in the management/decision-making of the company
Accept any other relevant feature.
Award [1] for a relevant feature with appropriate description up to a maximum of [2].
Reasons include:
- To reduce the risk associated with launching a new product (garrapiñada) to the Latin American markets in Miami Florida.
- To predict future demand for garrapiñada, which appears very important as the market was overwhelmed with positive response.
- Pablo needs up-to-date and relevant data.
- Pablo can further define his target market. Is it only Argentine and Uruguayan consumers?
- Some types of primary market research are inexpensive to conduct, which is important for a start-up.
Award [1] for each relevant reason explained and [1] for appropriate application to PP to a maximum of [2].
Break-even analysis is a forecasting tool. Advantages of BE include:
- Charts are relatively easy to construct and interpret and Pablo was able to make business decisions based on the results such as the doubling of profits.
- It provides a useful guideline to Pablo and allowed him to make decisions such as expanding the business to include a second truck.
- It provided guidance to the local Miami bank that helped them with their decision to make a loan.
Accept any other relevant advantage.
Disadvantages include:
- Break-even analysis/chart assumes that costs and revenues are always straight lines, which is unrealistic with costs such as the fuel for the truck.
- The break-even analysis/chart assumes that all peanuts produced are sold, which in reality may not be the case. I.e.: Demand at the different markets is unlikely to be constant.
- Break-even analysis/chart depends on accuracy of data and assumptions.
Accept any other relevant disadvantage.
Award [1] for an advantage and [1] for appropriate application to PP to a maximum of [2].
Award [1] for a disadvantage and [1] for appropriate application to PP to a maximum of [2].
Refer to Paper 2 markbands for 2016 forward, available under the "Your tests" tab > supplemental materials.
Option 1, the bank loan:
Advantages:
- Pablo gets to maintain 100 % ownership of PP. This also means Pablo maintains full decision-making power and PP.
- Pablo does not have to share his profits.
- The 10 % interest on the loan is tax deductible.
Disadvantages:
- There is a risk associated with the loan increasing the gearing ratio to 50 %
- Loan repayments ($10 000 per year) and the burden of the loan can be problematic for PP if the BE data is incorrect.
- Pablo and 1 other employee are the sole vendors of the garrapiñada. If something were to happen to them or the trucks, paying the loan could be difficult.
- Because of the loan repayment, Pablo can only take $10 000 in dividends.
Option 2, finance from an angel investor:
Advantages:
- Pablo gets much needed advice from Ana, who has an extensive experience in the Latin American food market.
- Pablo can share some of the management roles and responsibilities, which would allow him to focus on his truck and selling his products at the market.
- Pablo and PP do not have as much risk. 0 % gearing. Also, he would have no loan repayments and any costs associated with borrowing.
- Pablo can take a greater percentage of his profits in the form of dividends ($13 000)
Disadvantages
- Pablo must share his profits.
- Pablo is no longer the sole decision maker, which means decision-making will be slower and potential exists for disagreement with Ana.
It is expected that candidates provide a conclusion with a substantiated judgment.
Candidates can provide any conclusion and judgment as long as it is substantiated. Accept any other substantiated judgment.
Marks should be allocated according to the paper 2 markbands for May 2016 forward.
For one relevant issue that is one-sided, award up to [3]. For more than one relevant issue that is one-sided, award up to a maximum of [4].
A balanced response is one that provides at least one argument for and one argument against each option.
Award a maximum of [6] if the answer is of a standard that shows balanced analysis and understanding throughout the response with reference to the stimulus material but there is no judgment/conclusion.
Candidates cannot reach the [7–8] markband if they give judgment/conclusions that are not based on analysis/explanation already given in their answer.
Examiners report
Many candidates could state two characteristics of a business angel.
Most students could provide at least one reason why Pablo should do market research but not as many could provide two reasons or the candidates basically restated the first reason.
Most candidates choosing question five knew what a break-even analysis is but candidates struggled to apply their knowledge to the stimulus.
Many candidates knew how to answer this question, a debt-versus-equity financing problem. For the most part, candidates understood the expectations of the command word.
