Hw 13 0 Help Save & Exit Submit 10 2 Check my work Lou Barlow, a divisional mana
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Hw 13 0 Help Save & Exit Submit 10 2 Check my work 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. last three years. He has computed the cost and revenue estimates for each product as follows: His annual pay raises are determined by his division's return on investment or which has exceeded 21% each of the points Product A Product S tnitial investment Cost of equipment (zero salvage value Annual revenues and costss Sales revenues Variable expenses Depreeiation expense Fixed out-of-pocket operating costs 270,000 480,000 s320,000 420,000 $ 148,000 198,000 S 54,000 96,000 S 77,000 57,000 The company's discount rte is 19%. Click here to view Exhibit 138-1 and Exhibit 138-2, to determine the appropriate discount factor using tables. Required: 1. Calculate the payback period for each product 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 5. Calculate the simple rate of return for each product 6a. For each measure, identify whether Product A or Product B is preferred. 6b. Based on the simple rate of return, Lou Barlow would likely Complete this question by entering your answers in the tabs below Req Reqa 2 Req 3 Req 4 Req 5 Req 6A Req EB iculate the payback period for each product. (Round your answers to 2 decimal places)Explanation / Answer
Since the answers to all the sub-parts will depend on the project-wise cashflows and profits, let us start by tabulating the project-wise annual cashflows and profits. As given in the question, both the products have been evaluated for a tenure of 5 years.
In the subsequent sections of the table the answers have been provided with the explanations for the calculations given thereafter. While the Payback period, Net Present Value, Internal Rate of Return and Project Profitability Index are calculated on the basis of the Annual cashflow (calculation given in table below) generated by the products, the Simple Rate of Return is calculated on the basis of the Annual profit (calculation given in table below) generated by the products.
Product Evaluation
Product A
Product B
Data Provided
Initial investment
Cost of Equipment (zero salvage value) (A)
$ 270,000
$ 480,000
Annual revenues and costs
Sales revenues (B)
$ 320,000
$ 420,000
Variable expenses (C)
$ 148,000
$ 198,000
Depreciation expense (D)
$ 54,000
$ 96,000
Fixed out-of-pocket operating costs (E)
$ 77,000
$ 57,000
Company’s discount rate
19%
19%
Calculated Values
Annual cashflow (F = B – C – E)
$ 95,000
$ 165,000
Annual profit (G = B – C – D – E)
$ 41,000
$ 69,000
Payback period (H = A/F) (Answer 1)
2.84 years
2.91 years
Net Present Value (NPV[i]) (Answer 2)
$ 20,475.31
$ 24,509.76
Internal Rate of Return (IRR[ii]) (Answer 3)
22.35%
21.27%
Project Profitability Index (PPI[iii]) (Answer 4)
1.08
1.05
Simple rate of return (SRR = G/A) (Answer 5)
15.19%
14.38%
[i] Formula elaborated in explanation
[ii] Formula elaborated in explanation
[iii] Formula elaborated in explanation
Answer 1. Payback period is calculated as a ratio of the initial investment to the annual cashflow generated by the product. While the payback period doesn't take into account present value of the cashflows, it gives a simplistic estimate of the number of years it would take for the product's cashflows to cover for the initial investment made.
Answer 2. Since the Net Present Value requires us to factor in the discount rate of the company (in this case 19%) to discount the future cashflows to arrive at today's dollar value, the calculation is as given below:
Discounted Values (Product Cashflow*Discount Factor)
Product A
Product B
Discount Factor Calculation
Discount Factor
Product A
Product B
Initial Investment
-270,000.00
-480,000.00
-270,000.00
-480,000.00
Year 1 cashflow
95,000.00
165,000.00
1/(1+19%)
0.840336134
79,831.93
138,655.46
Year 2 cashflow
95,000.00
165,000.00
1/(1+19%)^2
0.706164819
67,085.66
116,517.20
Year 3 cashflow
95,000.00
165,000.00
1/(1+19%)^3
0.593415814
56,374.50
97,913.61
Year 4 cashflow
95,000.00
165,000.00
1/(1+19%)^4
0.498668751
47,373.53
82,280.34
Year 5 cashflow
95,000.00
165,000.00
1/(1+19%)^5
0.419049371
39,809.69
69,143.15
NPV
20,475.31
24,509.76
Answer 3. The Internal Rate of Return gives us the rate of return which would discount back the future cashflows to exactly match the initial investment amount and the same needs to be calculated either using the IRR function provided in a Financial Calculator or Excel spreadsheet. These functions internally run multiple iterations to arrive at a particular interest rate which essentially results in an NPV of zero.
Answer 4. Project Profitability Index is the ratio of the discounted future cashflows to the initial investment made. Essentially, a ratio of 1.0 would mean that the discounted cashflows are just enough to breakeven on the investment made, whereas a ratio of more than 1.0 would mean that the project is profitable (higher the ratio, more profitable is the project). Calculation for the same is given below:
Discounted Values (Product Cashflow*Discount Factor)
Product A
Product B
Discount Factor Calculation
Discount Factor
Product A
Product B
Year 1 cashflow
95,000.00
165,000.00
1/(1+19%)
0.840336134
79,831.93
138,655.46
Year 2 cashflow
95,000.00
165,000.00
1/(1+19%)^2
0.706164819
67,085.66
116,517.20
Year 3 cashflow
95,000.00
165,000.00
1/(1+19%)^3
0.593415814
56,374.50
97,913.61
Year 4 cashflow
95,000.00
165,000.00
1/(1+19%)^4
0.498668751
47,373.53
82,280.34
Year 5 cashflow
95,000.00
165,000.00
1/(1+19%)^5
0.419049371
39,809.69
69,143.15
Present Value (A)
290,475.31
504,509.76
Initial Investment (B)
270,000.00
480,000.00
Project Profitability Index (C=A/B)
1.08
1.05
Answer 5. Simple Rate of Return is calculated as the ratio of the Annual profit generated by the product to its initial investment as given in the first table containing the answers as well as the formula.
Product Evaluation
Product A
Product B
Data Provided
Initial investment
Cost of Equipment (zero salvage value) (A)
$ 270,000
$ 480,000
Annual revenues and costs
Sales revenues (B)
$ 320,000
$ 420,000
Variable expenses (C)
$ 148,000
$ 198,000
Depreciation expense (D)
$ 54,000
$ 96,000
Fixed out-of-pocket operating costs (E)
$ 77,000
$ 57,000
Company’s discount rate
19%
19%
Calculated Values
Annual cashflow (F = B – C – E)
$ 95,000
$ 165,000
Annual profit (G = B – C – D – E)
$ 41,000
$ 69,000
Payback period (H = A/F) (Answer 1)
2.84 years
2.91 years
Net Present Value (NPV[i]) (Answer 2)
$ 20,475.31
$ 24,509.76
Internal Rate of Return (IRR[ii]) (Answer 3)
22.35%
21.27%
Project Profitability Index (PPI[iii]) (Answer 4)
1.08
1.05
Simple rate of return (SRR = G/A) (Answer 5)
15.19%
14.38%
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