Lou Barlow a divisional manager for Sage Company has an oppo

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:

The company’s discount rate is 18%.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables.

Required:

1. Calculate the payback period for each product.

2. Calculate the net present value for each product.

3. Calculate the internal rate of return for each product.

4. Calculate the project profitability index for each product.

5. Calculate the simple rate of return for each product.

6a. For each measure, identify whether Product A or Product B is preferred.

6b. Based on the simple rate of return, Lou Barlow would likely:

Req 1

Req 2

Req 3

Req 4

Req 5

Req 6A

Req 6B

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

Calculate the net present value for each product. (Round your final answers to the nearest whole dollar amount.)

Calculate the internal rate of return for each product. (Round your answers to 1 decimal place i.e. 0.123 should be considered as 12.3%.)

Calculate the project profitability index for each product. (Round your answers to 2 decimal places.)

Calculate the simple rate of return for each product. (Round your answers to 1 decimal place i.e. 0.123 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:

	Product A	Product B
Initial investment:
Cost of equipment (zero salvage value)	$	250,000		$	460,000
Annual revenues and costs:
Sales revenues	$	300,000		$	400,000
Variable expenses	$	135,000		$	190,000
Depreciation expense	$	50,000		$	92,000
Fixed out-of-pocket operating costs	$	75,000		$	55,000

Solution

Calculation of Net Cash inflow & Operating Profit Product A Product B Sales Revenues               300,000            400,000 Less: Variable Expenses            (135,000)         (190,000) Less: Fixed out of Pocket Exp.               (75,000)            (55,000) Net Cash inflow                 90,000            155,000 Less: Dep.               (50,000)            (92,000) Net Operating Income                 40,000              63,000 Answer 1. Payback period = Intial investment / Cash Inflow per period Calculation of Pay Back Period Product A Product B Intial Investment (A)               250,000            460,000 Cash Inflow per Annum (B)                 90,000            155,000 Pay Back Period (A/B) 2.78 Years 2.97 Years Answer 2. Calculation of NPV of Project Particulars Year 18% Factor Project A Project B Amount Present value Amount Present value C D C X D E C X E Cash Inflow Net Cash Inflow 1 -5            3.12717                  90,000               281,445       155,000                484,711 A. Total Cash Inflow - PV               281,445                484,711 Cash Outflow Cost of Investment 0            1.00000                250,000               250,000       460,000     460,000.0000 B. Total Cash Outflow - PV               250,000                460,000 NPV (A - B)                 31,445                  24,711 Answer 3. Year Project A Project B Intial Investment 0         (250,000)             (460,000) Expcted Net Cash inflow 1              90,000                155,000 2              90,000                155,000 3              90,000                155,000 4              90,000                155,000 5              90,000                155,000 Internal Rate of Return 23.44% 20.35% Answer 4. Project Profitability Index = PV of cash Inflow / Intial Investment Project A Project B PV of Cash Inflow (A)               281,445            484,711 Intial investment (B)               250,000            460,000 Project Profitability Index (A/B)                      1.13                   1.05 Answer 5. Simple Rate of Return = Average Accounting Profit / Intial Investment Project A Project B Net operating profit (A)                 40,000              63,000 Intial Investment (B)               250,000            460,000 Simple Rate of Return (A/B) 16.00% 13.70% Answer 6a. Net Present Value Profitability Index Payback Period Internal Rate of Return Project B Project A Project A Project A Answer 6b. Reject Both Project Since, Simple rate of return is Less then the Expected rate of return (20%)