Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2592195 • 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 17% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
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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.
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 17% 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) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $180,000 S 390,000 $260,000 $124,000 36,000 71,000 S 360,000 S 174,000 S 78,000 S 51,000 The company's discount rate is 15%. Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor using tables. Required 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product B Payback period 2.77 years 2.89 years 2. Calculate the net present value for each product. (Round discount factor(s) to 3 decimal places.) Product A Product B Net present valueExplanation / Answer
Project A:
Initial Investment = $180,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $260,000 - $124,000 - $36,000 - $71,000
Annual Net Income = $29,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $29,000 + $36,000
Annual Net Cash flows = $65,000
Project B:
Initial Investment = $390,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $360,000 - $174,000 - $78,000 - $51,000
Annual Net Income = $57,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $57,000 + $78,000
Annual Net Cash flows = $135,000
Answer 2.
Project A:
Net Present Value = -$180,000 + $65,000 * PVA of $1 (15%, 5)
Net Present Value = -$180,000 + $65,000 * 3.3522
Net Present Value = $37,893
Project B:
Net Present Value = -$390,000 + $135,000 * PVA of $1 (15%, 5)
Net Present Value = -$390,000 + $135,000 * 3.352
Net Present Value = $62,520
Answer 3.
Project A:
Let IRR be i%
$180,000 = $65,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.7692
Using table values, i = 23.6%
So, IRR is 23.6%
Project B:
Let IRR be i%
$390,000 = $135,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.889
Using table values, i = 21.6%
So, IRR is 21.6%
Answer 4.
Product A:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $37,893 / $180,000
Profitability Index = 0.21
Product B:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $62,520 / $390,000
Profitability Index = 0.16
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