Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2805292 • 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 23% 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 $290,000 $490,000 $340,000 $440,000 $156,000 $206,000 $43,000 85,000 $ 79,000 59,000 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 yearsExplanation / Answer
Project A:
Initial Investment = $290,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $340,000 - $156,000 - $43,000 - $79,000
Annual Net Income = $62,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $62,000 + $43,000
Annual Net Cash flows = $105,000
Project B:
Initial Investment = $490,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $440,000 - $206,000 - $85,000 - $59,000
Annual Net Income = $90,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $90,000 + $85,000
Annual Net Cash flows = $175,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $290,000 / $105,000
Payback Period = 2.76 years
Project B:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $490,000 / $175,000
Payback Period = 2.80 years
Answer 2.
Project A:
Net Present Value = -$290,000 + $105,000 * PVA of $1 (15%, 5)
Net Present Value = -$290,000 + $105,000 * 3.3522
Net Present Value = $61,981
Project B:
Net Present Value = -$490,000 + $175,000 * PVA of $1 (15%, 5)
Net Present Value = -$490,000 + $175,000 * 3.3522
Net Present Value = $96,635
Answer 3.
Project A:
Let IRR be i%
$290,000 = $105,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.7619
Using table values and interpolation, i = 23.71%
So, IRR is 23.71%
Project B:
Let IRR be i%
$490,000 = $175,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.800
Using table values, i = 23.06%
So, IRR is 23.06%
Answer 4.
Product A:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $61,981 / $290,000
Profitability Index = 0.21
Product B:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $96,635 / $490,000
Profitability Index = 0.20
Answer 5.
Project A:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $62,000 / $290,000
Simple Rate of Return = 21.38%
Project B:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $90,000 / $490,000
Simple Rate of Return = 18.37%
Answer 6-a.
Net Present Value = Project B
Profitability Index = Project A
Payback Period = Project A
Internal Rate of Return = Project A
Answer 6-b.
Based on simple rate of return, both projects should be rejected as simple rate of return on both projects is under ROI.
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