EXHIBITS 13B-1 and 13B-2 are on bottom Lou Barlow, a divisional manager for Sage

Question

EXHIBITS 13B-1 and 13B-2 are on bottom

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: Product A Product B Initial investment Cost of equipment (zero salvage value) S340,000 540,000 Annual revenues and costs Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs S390,000 S490,000 S176,000 S226,000 S 48,000 S 90,000 S 84,000 68,000 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 1Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product A Product B Payback period years years 2. Calculate the net present value for each product. (Round discount factor(s) to 3 decimal places.) Product A Product B Net present value 3. Calculate the internal rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and Round discount factor(s) to 3 decimal places.) Product A Product B Factor of the internal rate of return

Explanation / Answer

Annual Cash flow = Project A = 390000 - 176000 - 84000 = $130000

Project B = 490000 - 226000 - 68000 = $196000

1) Payback Period: Project A = 340000 / 130000 = 2.62 years

Project B = 540000 / 196000 = 2.76 years

2) Net Present Value (Required rate of return 18%) =

Project A = (130000 * PVIFA(18, 5) ) - 340000 = (130000 * 3.127) - 340000 = $66510

Project B = (196000 * PVIFA(18, 5) ) - 540000 = (196000 * 3.127) - 540000 = $72892

3) IRR = Project A = PV(18, 5)= 406510   PV(22, 5) = 372320

IRR (project A) = 18% + 66510 * 4% / (406510 - 372320) = 25.78%

Project B = PV(18, 5)= 612892 PV(22, 5) = 561344

IRR (project B) = 18% + 72892 * 4% / (612892 - 561344) = 23.65%

4) Profitability Index = Project A = 406510 / 340000 = 1.195

Project B = 612892 / 540000 = 1.135

5) Simple rate of return =

Project A = Income per annum = $130000 - 48000 = $82000

Return = 82000 * 100 / 340000 = 24.12%

Project B = Income per annum = $196000 - 90000 = $106000

Return = 106000 * 100 / 540000 = 19.63%

6a) Preferance:

6b) Being NPV is higher and shorter IRR, the Project B will be preferred.

Net Present Value Profitability Index Pay back period IRR Project B Project A Project A Project B

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