Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufac
ID: 2521750 • 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: 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 $330,000 525,000 $380,000 $480,000 $172,000 $222,000 $66,000 $105,000 $83,000 63,000 The company's discount rate is 17% Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product A Product B Payback period years years Calculate the net present value for each product. (Use the appropriate table to determine the discount factor(s).) Product A Product B Net present value 3. 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.) Product A Product B Project profitability indexExplanation / Answer
Project A:
Initial Investment = $330,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $380,000 - $172,000 - $66,000 - $83,000
Annual Net Income = $59,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $59,000 + $66,000
Annual Net Cash flows = $125,000
Project B:
Initial Investment = $525,000
Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $480,000 - $222,000 - $105,000 - $63,000
Annual Net Income = $90,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $90,000 + $105,000
Annual Net Cash flows = $195,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $330,000 / $125,000
Payback Period = 2.64 years
Project B:
Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $525,000 / $195,000
Payback Period = 2.69 years
Answer 2.
Project A:
Net Present Value = -$330,000 + $125,000 * PVA of $1 (17%, 5)
Net Present Value = -$330,000 + $125,000 * 3.19935
Net Present Value = $69,918.75
Project B:
Net Present Value = -$525,000 + $195,000 * PVA of $1 (17%, 5)
Net Present Value = -$525,000 + $195,000 * 3.19935
Net Present Value = $98,873.25
Answer 3.
Product A:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $69,918.75 / $330,000
Profitability Index = 0.21
Product B:
Profitability Index = Net Present Value / Initial Investment
Profitability Index = $98,873.25 / $525,000
Profitability Index = 0.19
Answer 4.
Project A:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $59,000 / $330,000
Simple Rate of Return = 17.9%
Project B:
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $90,000 / $525,000
Simple Rate of Return = 17.1%
Answer 5-a.
Net Present Value = Project B
Profitability Index = Project A
Payback Period = Project A
Internal Rate of Return = Project A
Answer 5-b.
Accept Project A
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