Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2497753 • 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 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) $ 260,000 $ 470,000
Annual revenues and costs:
Sales revenues $ 310,000 $ 410,000
Variable expenses $ 144,000 $ 194,000
Depreciation expense $ 52,000 $ 94,000
Fixed out-of-pocket operating costs $ 76,000 $ 56,000
The company’s discount rate is 18%.
1.Calculate the payback period for each product.
2
Calculate the net present value for each product.
3.Calculate the project profitability index for each product.
4. Calculate the simple rate of return for each product.
5.For each measure, identify whether Product A or Product B is preferred.
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) $ 260,000 $ 470,000
Annual revenues and costs:
Sales revenues $ 310,000 $ 410,000
Variable expenses $ 144,000 $ 194,000
Depreciation expense $ 52,000 $ 94,000
Fixed out-of-pocket operating costs $ 76,000 $ 56,000
The company’s discount rate is 18%.
.
1.Calculate the payback period for each product.
2
Calculate the net present value for each product.
3.Calculate the project profitability index for each product.
4. Calculate the simple rate of return for each product.
5.For each measure, identify whether Product A or Product B is preferred.
Explanation / Answer
1)
Product A
Payback period = Initial Investment/Annual Cash flow
Payback period = 260000/90000
Payback period = 2.89 Years
Product B
Payback period = Initial Investment/Annual Cash flow
Payback period = 470000/150000
Payback period = 3.13 Years
2)
Product A
NPV = -initial investment + Annual Cash flow*(1-(1+r)^-n)/r
NPV = -260000 + 90000*(1-(1+18%)^-5)/18%
NPV = 21445.39
Product B
NPV = -initial investment + Annual Cash flow*(1-(1+r)^-n)/r
NPV = -470000 + 150000*(1-(1+18%)^-5)/18%
NPV = 924.35
3)
Product A
Project profitability index = (1+NPV/Initial Investment)
Project profitability index = (1+ 21445.39/260000)
Project profitability index = 1.082
Product B
Project profitability index = (1+NPV/Initial Investment)
Project profitability index = (1+ -924.35/470000)
Project profitability index = 0.998
4)
Product A
simple rate of return = Annual Net Income/Initial Investment
simple rate of return = 38000/260000
simple rate of return = 14.62%
Product B
simple rate of return = Annual Net Income/Initial Investment
simple rate of return = 66000/470000
simple rate of return = 14.04%
5)
Working
Product A
Initial investment = 260000
Annual Net Income = Sales revenues - Variable expenses - Depreciation expense - Fixed out-of-pocket operating costs
Annual Net Income = 310000-144000-52000-76000
Annual Net Income = $ 38000
Annual Cash Flow = Annual Net Income + Depreciation expense
Annual Cash Flow = 38000+52000
Annual Cash Flow = 90000
Product B
Initial investment = 470000
Annual Net Income = Sales revenues - Variable expenses - Depreciation expense - Fixed out-of-pocket operating costs
Annual Net Income = 410000-194000-94000-56000
Annual Net Income = $ 66000
Annual Cash Flow = Annual Net Income + Depreciation expense
Annual Cash Flow = 66000+94000
Annual Cash Flow = 150000
As per : Preferred Payback period Product A Net present value Product A Project profitability index Product A Simple rate of return Product ARelated Questions
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