Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2396759 • 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 22% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
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 22% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
Required: 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product A Product B Payback period years 2. Calculate the net present value for each product. (Round answers to the nearest dollar.) uct A Product B Net present value 3. Calculate the project profitability index for each product. (Round your answers to 2 decimal places.) uct A Product B Project profitability index 4. Calculate the simple rate of return for each product. (Round percentage answer to 1 decimal place, i.e. 0.1234 should be considered as 12.3%.) Product A Product B Simple rate of return 5a. For each measure, identify whether Product A or Product B is preferred Value Index PeriodExplanation / Answer
1. Computation of 'Payback Period':
Payback period = Total Initial capital Investment/ Annual net cash inflow
Annual Net cash flow
For A= $ (390,000- 178,000- 87,000) = $125000
For B= $ (470,000- 210,000- 67,000) = $1,93,000
Therefore, Payback Period (For A) = 350,000 / 125000 = 2.8 years
Payback Period (For B) = 550,000 /193000 = 2.85 years.
2. Calculation of 'Net Present Value'(NPV):
a) Net cash Inflows - same as computed in (1.) above.
b) Since cash inflows are uniform throughout the period of 5 years, we use cumulative discounting factor @ 20% which is = 2.991 for 5 years.
NPV= Present value of Inflows - Present values of outflow
A =$(125,000* 2.991) -$350,000 = $23875
B =$(193000* 2.991) -$550,000 = $ 27,263
It is computed as= Sum of Present value of cash inflows/ Initial Investment
PI (For A) = {(125000*2.926)/ 350,000} = 1.045 times
PI (For B) = {(193000*2.926)/ 550,000} = 1.03 times
4Calculation of Simple Rate of Return:
It is computed as: {Net Income / Investment} * 100
Net Income = Sales - Costs (Variable expenses + operating expenses+ depreciation expenses)
Net Income (For A) = $ {390000 -(178000+87,000+70000)} = $55,000
Net Income (For B) = $ {470,000 -(210,000+67000+110,000)} = $83,000
Therefore, Simple rate of return (For A) = (55,000 / 350,000)* 100 = 15.71 %
(For B) = (83,000 / 550,000)* 100 = 15.091%
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