Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2424726 • 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 24% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables.
Calculate the payback period for each product. (Round your answers to 2 decimal places.)
Calculate the net present value for each product. (Round discount factor(s) to 3 decimal places.)
Calculate the internal rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and Round discount factor(s) to 3 decimal places.)
Calculate the project profitability index for each product. (Round discount factor(s) to 3 decimal places. Round your answers to 2 decimal places.)
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%.)
For each measure, identify whether Product A or Product B is preferred.
Based on the simple rate of return, Lou Barlow would likely:
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 24% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
Explanation / Answer
1. payback period
product A = yearly cash inflow
= 370000-168000-82000 = 120000 (for 5 years)
payback period is = 330000/120000 = 2.75 years
Product B = yearly cash inflow
= 470000-218000- 68000
= 184000
payback period = 515000/184000
= 2.80 year
2. net present value of A
pv of future inflow
cash inlow from year 1 to 5 (370000-168000-82000) = $120000 * 3.352
PV of cash inflow $402240
PV of outflow $330000
NPV A (402240-330000) $72240
Present value of inflow from B
cash inflow from year 1 to 5 (184000)*3.352
PV of cash inflow 616768
PV of outlow $515000
NPV B (616768-515000) $101768
3. IRR
at IRR the NPV is 0 i.e net present value of inflow is equal to net present value of outflow
in case A net present value of outflow is 330000
IRR for A is:
As $120000 is the cash inflow for A=
120000*pvfa(IRR,5) = 330000
PVFA(IRR, 5) = 330000/120000 = 2.75
now find 2.75 in pvfa table for 5 year, it falls in between 23% and 24%
so , now we must interpolate to find the exact IRR
interpolation formula is = low rate+ npv at low rate/(npv at low rate - npv at high rate)* diff. in rate
now,
NPV at low rate i.e. 23% is (2.803*120000)-330000 = $6360
NPV at high rate i.e. 24% is (2.745*120000) - 330000 = -$600
IRR for A = 23+6360/(6360+600)*1 = 23.914%
For product B:
184000*pvfa(IRR,%) = 515000
PVFA(IRR,5) = 515000/184000 = 2.799
NOw look for 2.799 in pvfa table for 5 year:
it fall in between 23% and 24%
Now apply the interpolation similar to the product A = the IRR for B is 23.2% approx
5. simple rate of return.
investment in A = 330000
total incoming cash flow from A is = 120000*5 = $600000
return = (600000-330000)/330000= 81.82%
Investment in B = 515000
total incoming cash flow from B is = 184000*5 = 920000
return = (920000-515000)/515000 = 78.64%
6a.
payback period = A is preferred
NPV = B is preferred
IRR = A is preferred
6b.
accept A
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