Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2414194 • Letter: L
Question
Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products for a five-year period. His annual pay raises are determined by his division’s return on investment (ROI), which has exceeded 25% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
The company’s discount rate is 18%.
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables.
Required:
1. Calculate the payback period for each product.
2. Calculate the net present value for each product.
3. Calculate the internal rate of return for each product.
4. Calculate the project profitability index for each product.
5. Calculate the simple rate of return for each product.
6a. For each measure, identify whether Product A or Product B is preferred.
6b. Based on the simple rate of return, Lou Barlow would likely:
Product A Product B Initial investment: Cost of equipment (zero salvage value) $ 340,000 $ 540,000 Annual revenues and costs: Sales revenues $ 390,000 $ 490,000 Variable expenses $ 176,000 $ 226,000 Depreciation expense $ 68,000 $ 108,000 Fixed out-of-pocket operating costs $ 84,000 $ 64,000Explanation / Answer
Annual revenue 390000 490000 Less: Vraiable cost 176000 226000 Less: Fixed cost 84000 64000 Annual cash inflows 130000 200000 less: Annual dep 68000 108000 Annual net income 62000 92000 Average investment 170000 270000 req 1. Pay back periiod: Investmennt/ Annual cash inflows A: 340000 /62000 = 5.48 years B: 540000/92000 = 5.87 years Req 2: Net present value at 18% product A Product B Annual inflows 130000 200000 Annuity for 5 yeas at 18% 3.1272 3.1272 Present value of inflows 406536 625440 Less: Investment 340000 540000 NPV 66536 85440 Req 3: IRR Net present value at 18% product A Product B Annual inflows 130000 200000 Annuity for 5 yeas at 26.5% 2.6086 2.703 (at 24.75%) Present value of inflows 339118 540600 Less: Investment 340000 540000 NPV -882 600 Hence, IRR 26.50% 24.75% Req 4: Profitability Index: A B Present value of inflows 406536 625440 Divide: Investment 340000 540000 Profitability Indx 1.2 1.16 Req 5: A B Annual Income 62000 92000 Divide: Average Investment 170000 270000 Rate of return 36.47% 34.07% Rreq 6: Choose Payback A NPV B IRR A Profitability A Rreq 6-b: Product A shall be selected undere rate of return method.
Related Questions
Navigate
Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.