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 tw new products for a five year period His annual pay raises are detormined by his division\'s return on invest mint Ron which has exceeded 23% each of the last tree years He has computed the cost and revenue estimatos for each product as folows A Product B $500,000 Initial investment Cost of equipment (zero salvage value) Annual revenues and costs Sales revenues Variable expenses Depreciation expense Fied out-of- pocket operating costs $290000 350,000 $450,000 160 000 $210,000 58,000 $ 100.000 80,000 60,000 The company\'s discount rate is 16% Cick here to view Exhitit 118-1 and Exhibit 118.2 to determine the appropriate discount factorts) using tables Required: 1 Calculate the payback period for each product.(Round your answers to 2 declmal places.) Product Payback period Calculabe the net present value for each product (Use the appropriate table to deternine the discount factorts). 2 Product A Product B Net present value 3 Calculate the project pro@itablity ndex for each product (Use the appropriate table to determine the discount factorls). Round your answers to 2 decimal places) Project profitability indesx

Solution

Calculation of Net Cash Flows per year:-
Product A = 350000 - 160000 - 80000 = $110,000
Product B = 450000- 210000 -60000 = $180,000

Net Income Per year:- Cash Flows - Dep.
Product A = 110000 - 58000 = $52,000
Product B = 180000 - 100000 = $80,000

1). Payback Period = Initial Investment / Net cash inflows
Product A = 290000 / 110000 = 2.63 years
Product B = 500000 / 180000 = 2.77 years

2). Net Present Value = Present value of Cash flows - Initial Investment
Product A = ($110000 * PVAF 16% 5 years) - 290000
= (110000 * 3.274 ) - 290000
= 360140 - 290000 = $70,140

Product B = ($180000 * 3.274 ) - 500000
= 589320 - 500000 = $89,320

3). Profitability Index = PV of Future cash flows / Initial Investment
Product A = 360140 / 290000 = 1.24
Product B = 589320 / 500000 = 1.18

4). Simple rate of return = Net Income per year / Initial Investment
Product A = 52000 / 290000 = 17.93%
Product B = 80000 / 500000 = 16%

5a). Based on NPV = Product B
Based on Profitability Index = Product A
Based on Payback Period = Product A

5b). Based on simple rate of return = Product A.