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
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 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) | $ | 220,000 | $ | 410,000 | |
Annual revenues and costs: | |||||
Sales revenues | $ | 280,000 | $ | 380,000 | |
Variable expenses | $ | 130,000 | $ | 182,000 | |
Depreciation expense | $ | 44,000 | $ | 82,000 | |
Fixed out-of-pocket operating costs | $ | 73,000 | $ | 60,000 | |
The companys discount rate is 14%.
Click here to view Exhibit 7B-1 and Exhibit 7B-2, to determine the appropriate discount factor using tables.
Required:
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.
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