This question is from chapter 12 of Managerial Accounting 16 th edition by Ray G

Question

This question is from chapter 12 of Managerial Accounting 16th edition by Ray Garrison.

Problem 13-23 Comprehensive Problem [L013-1, LO13-2, LO13-3, LO13-5, LO13-6] 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: 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 260,000 470,000 $ 310,000 410,000 $ 144,000 194,000 $ 52,000 94,000 $ 76,000 58,000 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.

Explanation / Answer

Annual cash flows and Net income Product A Product B Sales revennue 310000 410000 Less: Variable expense 144000 194000 Less: Fixed expense 76000 58000 Annual cash inflws 90000 158000 Less: Depreciation 52000 94000 Annual Net income 38000 64000 Initial Investment 260000 470000 Average Investment (Investment/2) 130000 235000 Req 1: Payback periiod: Product A ProductB Initial Investment 260000 470000 Divide: Annual Cash inflows 90000 158000 Payback period in years 2.89 2.97 years Req 2: Net Present values Product A Product B Annual cash inflows 90000 158000 Annuity factor for 18% for 5 years 3.127 3.127 Present value of inflows 281430 494066 Less: Initial investtment 260000 470000 Net present value 21430 24066 Req 3: Internal rate of return Product A Product B Annual cash inflows 90000 158000 Annuity factr for 21.50% 2.895 Annuity factor for 20.25% 2.974 Present valueof inflws 260550 469892 Less: Initial investment 260000 470000 NPV 550 -108 Hence, IRR 21.50% 20.25% Req 4. Profitability Index Product A Product B Present value of inflows 281430 494066 Divide: Initial Investment 260000 470000 Profitability Index 1.08 1.05 Req 5: Simple Rate of return Product A Product B Annual Net income 38000 64000 Divide: Average Invetsment 130000 235000 Average Rate of return 29.23% 27.23% Req 6: NPV PI Payback IRR Simple rate of return Product B Product A Product A Product A Product A Req 7. Accept Pproduct A

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