Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac

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 22% each of the last three years. He has computed the cost and revenue estimates for each product as follows:

  

The company’s discount rate is 20%.

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

Calculate the payback period for each product. (Round your answers to 2 decimal places.)

Calculate the net present value for each product. (Use the appropriate table to determine the discount factor(s).)

  

Calculate the project profitability index for each product. (Use the appropriate table to determine the discount factor(s). 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% and use the appropriate table to determine the discount factor(s).)

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 22% 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) $ 350,000 $ 550,000   Annual revenues and costs:   Sales revenues $ 390,000 $ 470,000   Variable expenses $ 178,000 $ 210,000   Depreciation expense $ 70,000 $ 110,000   Fixed out-of-pocket operating costs $ 87,000 $ 67,000

The company’s discount rate is 20%.

Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables.

1.

Calculate the payback period for each product. (Round your answers to 2 decimal places.)

Explanation / Answer

Ans-

1. Payback period is the period in which cost of investment can be recovered.It does not take time value of money in consideration.

Here is the formula for calculating it-

Payback period = Y + ( A / B ) where

Y = years before the payback year

A = Total cash flow remaining to be paid back at the start of the break-even year, for bringing cumulative cash flow to 0.

B = Total cash flow in the entire payback year

Project B

As per above calculations,Project A is little better than project b as it can recover the investment in 2.80 years.

Year Investment Cash Inflow Unrecovered investment 1 $350,000.00 $125,000.00 $                    225,000.00 2 $125,000.00 $                    100,000.00 3 $125,000.00

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