Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2472534 • 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 25% 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 25% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
Explanation / Answer
1) Pay back period:
Payback period = Initial investment/annual cash flow
Product A:
Payback period = $340000 / $125000 = 2.72 years
Product B:
Payback period = $525000 / $192000 = 2.73 years
2)
NPV of product A = $125000 x PVIFA (17%, 5) - $340000 = $125000 x 3.199 -$340000 = $59875
NPV of product B = $192000 x PVIFA(17%,5) - $525000 = $192000 x 3.199 - $525000 = $89208
3) Internal rate of return:
At IRR, the NPV will be zero.
IRR for product A:
NPV at 30% = 125000*2.436-340000 = -$35500
NPV at 17% = $59875
By Interpolation we get:
R = = 17% + 13% * ((0-59875)/(-35500-59875) = 25.16%
Product B:
NPV at 30% = 192000*2.436-525000 = -$57288
NPV at 17% = $89208
R = 17% + 13% * ((0-89208)/(-57288-89208) = 24.92%
4) Profitability Index = 1 + NPV/initial investment
Product A:
Profitability Index = 1 + $59875/$340000 = 1.18
Product B:
Profitability Index = 1 + $89208/$525000 = 1.17
5)
Simple rate of return
= Incremental net operating income / (Initial investment-Salvage value)
salvage value for both the investment is zero
Product A:
Simple rate of return = $125000/$340000 = 36.76%
Product B:
Simple rate of return = $192000 / $525000 = 36.57%
6a) For Pay back period, Profitability index, Internal rate of return and Simple rate of return, Product A is showing a slightly better performace than product B. However, for NPV product B is showing higher NPV than that of A.
6b) Accept product A.
Products A B Sales revenue $ 3,80,000.00 $ 4,80,000.00 Variable expenses $ -1,72,000.00 $ -2,22,000.00 depreciation $ -47,000.00 $ -89,000.00 Fixed out of pocket expenses $ -83,000.00 $ -66,000.00 Net Income $ 78,000.00 $ 1,03,000.00 Add: depreciation $ 47,000.00 $ 89,000.00 Net cash flow $ 1,25,000.00 $ 1,92,000.00Related Questions
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