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 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%.
Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor using tables.
Required:
1. Calculate the payback period for each product. (Round your answers to 2 decimal places.)
2. Calculate the net present value for each product. (Round discount factor(s) to 3 decimal places.)
3. Calculate the internal rate of return for each product. (Round percentage answers to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and round discount factor(s) to 3 decimal places.)
4. Calculate the project profitability index for each product. (Round discount factor(s) to 3 decimal places. Round your answers to 2 decimal places.)
5. Calculate the simple rate of return for each product. (Round percentage answers to 1 decimal place. i.e. 0.1234 should be considered as 12.3%.)
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:
Accept Product A | |
Accept Product B | |
Reject both products |
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