EXHIBITS ARE ON BOTTOM Lou Barlow, a divisional manager for Sage Company, has an

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EXHIBITS 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 22% 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 Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs S 30,000575,000 5410,000 490,000 5188,000 218,000 S 53,000 95,000 5 89,000 70,000 The company's discount rate is 20%. 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. (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

Explanation / Answer

Sage Company (All amounts in $) Product A Product B Initial Investment (Year 0) -380000 -575000 Earnings per year (Cash Inflow) Sales less Variable Expenses 135000 325000 1. Payback period for each product Payback Period for Product A 2 years 10 months = 2.98 years Payback Period for Product B 1 year 9 months = 1.92 years 2. Based on the information given, and the discount rate as 20% NPV of Product A $ 19,777.20 NPV of Product B $ 330,790.79 3. Since the discount rate of Sage Company is 20%, the IRR for each product will be IRR for Product A 22.81% IRR for Product B 48.76% 4. The Profitability Index is calculated using the formula NPV / Initial Investment Hence, the Profitability Index for Product A is 0.052045263 : 1 The Profitability Index for Product B is 0.57528833 : 1 5. For the simple rate of return, we need to deduct Depreciation from the Cash Inflows per year For Product A, the Net Income works out to 82000 For Product B, the Net Income works out to 230000 The Simple Rate of Return for each product will be Product A 21.58% Product B 40% 6a. For each measure the product preferred is : Payback Period NPV IRR Profitability Index Product B Product B Product A Product B 6b. Based on the simple rate of return, Lou Barlow would be likely to accept Product B.

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