Lou Barlow a divisional manager for sage company. Has an opportunity to manufact
ID: 2471287 • 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 return on investment (ROI), Which has exceeded 18% each of the last three years. He has computed the cost and revenue estimates for each product as fllows The company's discount rate is 16% Required: Calculate the payback period for each product. Calculate the net present value for each reluctance. Calculate the internal rate of return for each product. Calculate the project profitability index for each product. Calculate the simple rate of return for each product. Which of the two products should Lou's division pursue? Why?Explanation / Answer
PI =
Profitability Index= Present Value of Future Cash Flows / Initial Investment Required
= 1 + Net Present Value / Initial Investment Required
Simple return:
The simple rate of return is the incremental amount of net income expected from a prospective investment opportunity, divided by the investment in it. The simple rate of return is used for capital budgeting analysis, to determine whether a business should invest in a fixed asset and any incremental change in working capital associated with the asset. For example, if there is an opportunity under which a business can earn an incremental increase in its net profit of $8,000 in exchange for an initial investment of $100,000, then the project has a simple rate of return of 8% (calculated as $8,000 incremental net income / $100,000 investment).
The formula for IRR is:
0 = P0 + P1/(1+IRR) + P2/(1+IRR)2 + P3/(1+IRR)3 + . . . +Pn/(1+IRR)n
where P0, P1, . . . Pn equals the cash flows in periods 1, 2, . . . n, respectively; and
IRR equals the project's internal rate of return.
The company should select project B because it has more NPV
Year Product A PV@16% Product B PV@16% 0 (170,000) (170,000) (380,000) (380,000) 1 60,000 51,724 130,000 112,069 2 60,000 44,590 130,000 96,611 3 60,000 38,439 130,000 83,285 4 60,000 33,137 130,000 71,798 5 60,000 28,567 130,000 61,895 NPV 26,458 NPV 45,658 IRR 5.60% IRR 4.35% Payback 2.17 Payback 2.92 PI Index 1.16 PI Index 1.12 Simple return 35.29% Simple return 34.21%Related Questions
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