Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2433208 • 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 20% 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) $ 260,000 $ 470,000 Annual revenues and costs: Sales revenues $ 310,000 $ 410,000 Variable expenses $ 144,000 $ 194,000 Depreciation expense $ 52,000 $ 94,000 Fixed out-of-pocket operating costs $ 76,000 $ 58,000Explanation / Answer
Req a1: Payback period Product A Product B Initial investment 260000 470000 Divide: Annual cashinflows 90000 158000 Payback period 2.89 2.97 Req 2: NPV Product A Product B Annual Inflows 90000 158000 Annuity PV factor at 8% 3.9927 3.9927 Present value of inflows 359343 630846.6 Less: Initial investment 260000 470000 NPV 99343 160846.6 Req 3: IRR Product A Product B Annual Inflows 90000 158000 Annuity PV factor (at 21.60%) 2.8889 2.9742 (at 20.25%) Present value of inflows 260001 469923.6 Less: Initial investment 260000 470000 NPV 1 -76.4 IRR 21.60% 20.25% Req 4: Profitability Index: Product A Product B Annual Inflows 90000 158000 Annuity PV factor at 8% 3.9927 3.9927 Present value of inflows 359343 630846.6 Divide:Initial Investment 260000 470000 Profitability Index 1.38 1.34 Req 5: Product A Product B Net income 38000 64000 Divide: Average Investment 130000 235000 Average rate of return 29.23% 27.23% Req 6: Preference Payback Product A NPV Product B IRR Product A PI Product A SIMPLE Rate of Return Product A Req 6-b: Lou Barlow would likely to accept both the products.
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