Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2599475 • 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 24% 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 $330,000 515,000 $370,000 $470,000 $168,000 $218,000 $46,000$ 88,000 $82,000$ 68,000 The company's discount rate is 15% Click here to view Exhibit 13B-1 and Exhibit 13B-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 A Product B Payback period years 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
Cash inflows each year = Sales revenues - Variable expenses - Fixed out-of-pocket operating costs
Annual cash inflows each year for Product A = 370,000 - 168,000 - 82,000 = 120,000
Annual cash inflows each year for Product B = 470,000 - 218,000 - 68,000 = 184,000
1.
Payback period = Initial investment / Annual cash inflows each year
2.
Net present value = Present value of cash inflows - Present value of cash outflows
Present value annuity factor of 15% for 5 years = 3.352
3.
Internal rate of return = Initial investment / Annual cash flows each year
4.
Profitability index = Present value of cash inflows / Present value of cash outflows
5.
Operating income = Sales revenues - Variable expenses - Depreciation expense - Fixed out-of-pocket operating costs
Operating income for Product A = 370,000 - 168,000 - 46,000 - 82,000 = 74,000
Operating income for Product B = 470,000 - 218,000 - 88,000 - 68,000 = 96,000
Simple rate of return = Operating income / Investment
6a.
Product A Product B Payback period 2.75 years (330,000/120,000) 2.80 years (515,000/184,000)Related Questions
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