Question
Comprehensive Problem - Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products for a
Comprehensive Problem - 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 divisions 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 companys discount rate is 20%.
2. Calculate the net present value for each product.
Product A Product B
Annual cash flow $125,000 $193,000
Discount Rate 20% 20%
PVA 20% for 5 years 2.991 2.991 --- how to get this
Present value cash flow $373,875 $577,263
Investm. $350,000 $550,000
Net present value $23,875 $27,263
3. Calculate the internal rate of return for each product.
Product A Product B
Investm. $350,000 $550,000
ACF $125,000 $193,000
PVA 2.80 2.85
Discounted rate for 5 years 23.1% - how to get this 22.2% - how to get this
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