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 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: Product A Product B Initial investment: Cost of equipment (zero salvage value) $ 170,000 $ 380,000 Annual revenues and costs: Sales revenues $ 250,000 $ 350,000 Variable expenses $ 120,000 $ 170,000 Depreciation expense $ 34,000 $ 76,000 Fixed out-of-pocket operating costs $ 70,000 $ 50,000 The company’s discount rate is 16%.

1.Calculate the project profitability index for each product

2.Calculate the net present value for each product.

3.Calculate the simple rate of return for each product

Explanation / Answer

Product A Product B Sale            250,000         350,000 Variable Expenses            120,000         170,000 Fixed Out of pocket operating Cost              70,000           50,000 Net Cash Inflow each year              60,000         130,000 1 Profitability Index PV of futue cash Flow/Initial Investment A B Initial Investment 170000 380000 PV of Future cash Flow 26458 45658 Profitability Index 15.6% 12.0% 2 NPV For A Cash Flow NPV Year 0          -170,000       -170,000 Year 1              60,000           51,724 Year 2              60,000           44,590 Year 3              60,000           38,439 Year 4              60,000           33,137 Yaer 5              60,000           28,567 NPV           26,458 NPV For B Cash Flow NPV Year 0          -380,000       -380,000 Year 1            130,000         112,069 Year 2            130,000           96,611 Year 3            130,000           83,285 Year 4            130,000           71,798 Yaer 5            130,000           61,895 NPV           45,658 Simple rate of return Net Profit/ Initial Investmnet Product A Product B Sale            250,000         350,000 Variable Expenses            120,000         170,000 Fixed Out of pocket operating Cost              70,000           50,000 Depriciation              34,000           76,000 Net Profit              26,000           54,000 Initial Investment 170000 380000 Simple rate of return 15.3% 14.2%

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