Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2614778 • 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 21% 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 $270,000 $480,000 $320,000 $420,000 $148,000 $198,000 $54,000$ 96,000 $ 77,000$ 57,000 The company's discount rate is 19% Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) 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 Calculate the net present value for each product. (Use the appropriate table to determine the discount factor(s).) Product A Product B Net present valueExplanation / Answer
Project A:
Initial Investment = $270,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $320,000 - $148,000 - $54,000 - $77,000
Annual Net Income = $41,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $41,000 + $54,000
Annual Net Cash flows = $95,000
Project B:
Initial Investment = $480,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $420,000 - $198,000 - $96,000 - $57,000
Annual Net Income = $69,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $69,000 + $96,000
Annual Net Cash flows = $165,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $270,000 / $95,000
Payback Period = 2.84 years
Project B:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $480,000 / $165,000
Payback Period = 2.91 years
Answer 2.
Project A:
Net Present Value = -$270,000 + $95,000 * PVA of $1 (19%, 5)
Net Present Value = -$270,000 + $95,000 * 3.0576
Net Present Value = $20,472
Project B:
Net Present Value = -$480,000 + $165,000 * PVA of $1 (19%, 5)
Net Present Value = -$480,000 + $165,000 * 3.0576
Net Present Value = $24,504
Answer 3.
Product A:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $20,472 / $270,000
Profitability Index = 0.08
Product B:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $24,504 / $480,000
Profitability Index = 0.06
Answer 4.
Project A:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $41,000 / $270,000
Simple Rate of Return = 15.2%
Project B:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $69,000 / $480,000
Simple Rate of Return = 14.4%
Answer 5-a.
Net Present Value = Project B
Profitability Index = Project A
Payback Period = Project B
Answer 5-b.
Based on the simple rate of return, Low Barlow would likely to reject both projects.
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