Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2798595 • 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 18% 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 $170,000 380,000 nnual revenues and costs Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $250,000 $350,000 $120,000 $170,000 $ 34,000 $ 76,000 $70,000 $ 50,000 The company's discount rate is 16% 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 yearsExplanation / Answer
Project A:
Initial Investment = $170,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $250,000 - $120,000 - $34,000 - $70,000
Annual Net Income = $26,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $26,000 + $34,000
Annual Net Cash flows = $60,000
Project B:
Initial Investment = $380,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $350,000 - $170,000 - $76,000 - $50,000
Annual Net Income = $54,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $54,000 + $76,000
Annual Net Cash flows = $130,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $170,000 / $60,000
Payback Period = 2.83 years
Project B:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $380,000 / $130,000
Payback Period = 2.92 years
Answer 2.
Project A:
Net Present Value = -$170,000 + $60,000 * PVA of $1 (16%, 5)
Net Present Value = -$170,000 + $60,000 * 3.2743
Net Present Value = $26,458
Project B:
Net Present Value = -$380,000 + $130,000 * PVA of $1 (16%, 5)
Net Present Value = -$380,000 + $130,000 * 3.2743
Net Present Value = $45,659
Answer 3.
Project A:
Let IRR be i%
$170,000 = $60,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.833
Using table values, i = 22.5%
So, IRR is 22.5%
Project B:
Let IRR be i%
$380,000 = $130,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.923
Using table values, i =21.1 %
So, IRR is 21.1%
Answer 4.
Product A:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $26,458 / $170,000
Profitability Index = 0.16
Product B:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $45,659 / $380,000
Profitability Index = 0.12
Answer 5.
Project A:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $26,000 / $130,000
Simple Rate of Return = 20.0%
Project B:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $54,000 / $380,000
Simple Rate of Return = 14.2%
Answer 6-a.
Net Present Value = Project B
Profitability Index = Project A
Payback Period = Project A
Internal Rate of Return = Project A
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