Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2424734 • 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:
Use this chart to solve
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
Foor product A
Payback period = Cash outflow or Initial Investment/ Cash inflows per year
Cash inflow per year = Sales Revenue - Variable expense - Fixed cost = 370,000-168000-82000 = $120,000
Cash ouflow = $330,000
Therefore payback period = 330,000/120,000 = 2.75
For Product B
Cash inflow per year = 470,000-218,000-88,000 = $164,000
Cash outflow = $515,000
Therefore payback period = 515,000/164,000 = 3.14
2) Net present value
For product A
Cash Inflow per year (as calculated in part a) = $120,000
Present value of cash inflows = Cash Inflow {(1+i)^n-1}/i(1+i)^n = 120,000{(1+0.15)^5-1}/0.15(1+0.15)^5
= $402,258.61
Cash Outflow = $330,000
Therefore, Net Present value = Present value of cash inflows - cash outflow
= 402,258.61-330,000 = $72,258.61
For Product B
Cash inflow as per part 1 = $164,000
Cash outlow = $515,000
Net present value of cash inflows
Cash Inflow {(1+i)^n-1}/i(1+i)^n = 164,000{(1+0.15)^n-1}/0.15(1+0.15)^5
= $549,728
Therefore, Net Present value = Present value of cash inflows - cash outflow
= 549,728-515,000 = $34,728
4) Project profitability Index
For project A
Profitability index = P.V. of cash inflows(as calculated in part 2)/Initial investment = 402,258.61/330,000 = 1.219
For poject B
Profitability index = P.V. of cash inflows(as calculated in part 2)/Initial investment = 549,728/515,000 = 1.067
5) Simple rate of return
For project A
Simple rate of return = Cash inflow per year / Initial Investment*100 = 120,000/330,000*100 = 36.4%
For project B
Simple rate of return = Cash inflow per year / Initial Investment*100 = 164,000/515,000*100 = 31.8%
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