Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac

Question

Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell ne of two new pro period. His annual pay raises are determined by his division's return on investment (ROD) He has computed the cost and revenue estimates for each product as follows his division's return on investment (RO), which has exceeded 20% each of the last three years. Product A Product B s 220,000 410,809 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 280,000 380,000 s 130,000 182,009 S 44,80082,000 73,800 60,809 The company's discount rate is 14%. Click here to view Exhibit 13B-1 and Exhibit 13B 2, to determine the appropriate discount factor using tobles Required: 1. Colculate 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 lkely

Explanation / Answer

Annual inflows and Annual net income Product A Product B Sales revenue 280000 380000 Less: Operating expense variable 130000 182000 Fixed 73000 60000 Annual Cash inflows 77000 138000 Less: Depreciation 44000 82000 Annual Net income 33000 56000 Average investment 110000 205000 Req 1: Payback period Product A Product B Initial investment 220000 410000 Divide: Annual Inflows 77000 138000 Payback periodd 2.86 2.97 Req 2: NPV: Product A Product B Annual inflows 77000 138000 Annuity present value factor for 5 yrs 3.432 3.432 Present value of inflows 264264 473616 Less: Initial Investment 220000 410000 NPV 44264 63616 Req 3: IRR Product A Product B Annual inflows 77000 138000 Annuity present value factor for 5 yrs (At 22%) 2.8636 2.9742 (at 20.25%) Present value of inflows 220497.2 410439.6 Less: Initial Investment 220000 410000 NPV 497.2 439.6 IRR 22% 20.25% Req 4: Profitability Index: Product A Product B Annual inflows 77000 138000 Annuity present value factor for 5 yrs 3.432 3.432 Present value of inflows 264264 473616 Divide: Initial Investment 220000 410000 Profitability Index 1.2 1.16 Req 5: Simple rate of return: Product A Product B Annual net income 33000 56000 Divide: Average investment 110000 205000 Simple rate of return 30% 27.32% (Annual net income/Average investment) *100 Req 6-a: Preference Payback period Product A NPV Product B IRR Producct A Profitability Index Product A Simple rate of return Product A Req 6-b: To accept both the products

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