Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2414385 • 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 20% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
The company’s discount rate is 18%.
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.
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:
Req 1
Req 2
Req 3
Req 4
Req 5
Req 6A
Req 6B
Calculate the payback period for each product. (Round your answers to 2 decimal places.)
Calculate the net present value for each product. (Round your final answers to the nearest whole dollar amount.)
Calculate the internal rate of return for each product. (Round your answers to 1 decimal place i.e. 0.123 should be considered as 12.3%.)
Calculate the project profitability index for each product. (Round your answers to 2 decimal places.)
Calculate the simple rate of return for each product. (Round your answers to 1 decimal place i.e. 0.123 should be considered as 12.3%.)
For each measure, identify whether Product A or Product B is preferred.
Based on the simple rate of return, Lou Barlow would likely:
Product A Product B Initial investment: Cost of equipment (zero salvage value) $ 250,000 $ 460,000 Annual revenues and costs: Sales revenues $ 300,000 $ 400,000 Variable expenses $ 135,000 $ 190,000 Depreciation expense $ 50,000 $ 92,000 Fixed out-of-pocket operating costs $ 75,000 $ 55,000Explanation / Answer
Calculation of Net Cash inflow & Operating Profit Product A Product B Sales Revenues 300,000 400,000 Less: Variable Expenses (135,000) (190,000) Less: Fixed out of Pocket Exp. (75,000) (55,000) Net Cash inflow 90,000 155,000 Less: Dep. (50,000) (92,000) Net Operating Income 40,000 63,000 Answer 1. Payback period = Intial investment / Cash Inflow per period Calculation of Pay Back Period Product A Product B Intial Investment (A) 250,000 460,000 Cash Inflow per Annum (B) 90,000 155,000 Pay Back Period (A/B) 2.78 Years 2.97 Years Answer 2. Calculation of NPV of Project Particulars Year 18% Factor Project A Project B Amount Present value Amount Present value C D C X D E C X E Cash Inflow Net Cash Inflow 1 -5 3.12717 90,000 281,445 155,000 484,711 A. Total Cash Inflow - PV 281,445 484,711 Cash Outflow Cost of Investment 0 1.00000 250,000 250,000 460,000 460,000.0000 B. Total Cash Outflow - PV 250,000 460,000 NPV (A - B) 31,445 24,711 Answer 3. Year Project A Project B Intial Investment 0 (250,000) (460,000) Expcted Net Cash inflow 1 90,000 155,000 2 90,000 155,000 3 90,000 155,000 4 90,000 155,000 5 90,000 155,000 Internal Rate of Return 23.44% 20.35% Answer 4. Project Profitability Index = PV of cash Inflow / Intial Investment Project A Project B PV of Cash Inflow (A) 281,445 484,711 Intial investment (B) 250,000 460,000 Project Profitability Index (A/B) 1.13 1.05 Answer 5. Simple Rate of Return = Average Accounting Profit / Intial Investment Project A Project B Net operating profit (A) 40,000 63,000 Intial Investment (B) 250,000 460,000 Simple Rate of Return (A/B) 16.00% 13.70% Answer 6a. Net Present Value Profitability Index Payback Period Internal Rate of Return Project B Project A Project A Project A Answer 6b. Reject Both Project Since, Simple rate of return is Less then the Expected rate of return (20%)
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