Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2487095 • 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 23% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.
Calculate the payback period for each product. (Round your answers to 2 decimal places.)
Calculate the net present value for each product. (Use the appropriate table to determine the discount factor(s).)
Calculate the project profitability index for each product. (Use the appropriate table to determine the discount factor(s). Round your answers to 2 decimal places.)
Project Profitability Index:
Calculate the simple rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and use the appropriate table to determine the discount factor(s).)
Simple Rate of Return:
For each measure, identify whether Product A or Product B is preferred.
Net Present Value:
Profitability Index:
Payback Period:
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 $ 480,000 Annual revenues and costs: Sales revenues $ 330,000 $ 430,000 Variable expenses $ 152,000 $ 202,000 Depreciation expense $ 52,000 $ 96,000 Fixed out-of-pocket operating costs $ 78,000 $ 58,000Explanation / Answer
Answer: 1
Answer:2
NPV of product A = -260000 + 100000*PVIFA(14%,5)
= -260000 + 100000*3.433
= -260000 + 343300 = $83300
NPV of product B = -480000 + 170000*PVIFA(14%,5)
= -480000 + 170000*3.433
= -480000 + 583610 = $103610
Answer:3
Profitability index = NPV/initial investment
Product A: 83300/260000 = 0.32
Product B: 103610/480000 = 0.22
Answer:4
Simple rate of return = (Annual cash inflow - Depreciation expense)/initial investment
Product A: (100000 - 52000)/260000
= 48000/260000 = 18.5%
Product B: (170000-96000)/480000
= 74000/480000 = 15.4%
Answer: 5- a
Net Present Value: Product B (has higher NPV than product A)
Profitability Index: Product A (has higher PI than Product B)
Payback Period: Product A (has lower payback period than product B)
Answer: 5-b
Reject both projects because simple rate of return does not take into account the time value of money.
Product A Product B Sales revenue 330000 430000 Less: Variable expenses 152000 202000 Less: Fixed out of pocket opertaing costs 78000 58000 Annual net cash inflows (b) 100000 170000 Investment required (a) 260000 480000 Payback period (a)/(b) 2.6 2.82Related Questions
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