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 14B-1 (https://ezto-cf-media.mheducation.com/Media/Connect_Production/bne/accounting/garrison_17e/Exhibit/Exhibit_14B_1.htm) and Exhibit 14B-2 (https://ezto-cf-media.mheducation.com/Media/Connect_Production/bne/accounting/garrison_17e/Exhibit/Exhibit_14B_2.htm), to determine the appropriate discount factor using tables.

Required:

1. Calculate the payback period for each product. (in years)

2. Calculate the net present value for each product.

3. Calculate the internal rate of return for each product. (%)

4. Calculate the 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.

Answer

Net Present Value: B

Profitability Index: A

Payback Period: A

Internal Rate of Return: A

Simple Rate of Return: A

6b. Based on the simple rate of return, which of the two products should Lous division accept?

Answer: Reject both products