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

Question

Loo 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 18% each of the last three years He has computed the cost and revenue estimates for each product as follows Calculate the payback period for each product. Calculate the net present value for each product. Calculate the internal rate of return for each product. Calculate the project profitability index for each product. Calculate the simple rate of return for each product. Which of the two products should Lou's division pursue? Why?

Explanation / Answer

Computation of annual cash inflows:

1. Payback period for each product: Initial investment / Annual cash flows

2. Net present value for each product:Present value of cash inflows - Initial investment

3. Internal rate of return for each product: (Using Excel)

4. Profitability index for each product:Present value of cash inflows / Initial investment

5. Simple rate of return for each product: Accounting income / Initial investment x 100

6. Other than NPV, all the other evaluation parameters are in favor of Product A.

Product A Product B Sales revenues $ 250,000 $ 350,000 Variable expenses $ 120,000 $ 170,000 Fixed out of pocket operating costs $ 70,000 $ 50,000 Net cash inflows $ 60,000 $ 130,000 Accounting income $ 26,000 $ 54,000

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