The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and then sold the cars after three years of use. The companys present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet, the company is considering two alternatives:
Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three years of use. Ten cars will be needed, which can be purchased at a discounted price of $31,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole:
Annual cost of servicing, taxes, and licensing $ 4,700
Repairs, first year $ 2,600
Repairs, second year $ 5,100
Repairs, third year $ 7,100
At the end of three years, the fleet could be sold for one-half of the original purchase price.
Lease alternative: The company can lease the cars under a three-year lease contract. The lease cost would be $66,000 per year (the first payment due at the end of Year 1). As part of this lease cost, the owner would provide all servicing and repairs, license the cars, and pay all the taxes. Riteway would be required to make a $13,000 security deposit at the beginning of the lease period, which would be refunded when the cars were returned to the owner at the end of the lease contract.
Riteway Ad Agencys required rate of return is 16%.
Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What is the net present value of the cash flows associated with the purchase alternative?
2. What is the net present value of the cash flows associated with the lease alternative?
3. Which alternative should the company accept?
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(Round your percentage answers to 1 decimal place i.e. 0.123 should be considered as 12.3%.) Product A 22.6% Product B 21.31% Internal rate of return Reg 1 Reg 3 Reg 2 Reg 4 Req 6A Reg 5 Req 6B Calculate the profitability Index for each product. (Round your answers to 2 decimal places.) Product A Product B 0.21 0.17 Profitability index 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 division's return on investment (ROI), which has exceeded 17% each of the last three years. He has computed the cost and revenue estimates for each product as follows: Product B Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs Product A $ 180,000 $ 260,000 $ 124,000 $ 36,000 $ 71,000 $ 390,000 $360,000 $ 174,000 $ 78,000 $ 50,000 The company's discount rate is 15%. Click here to view Exhibit 148.1 and Exhibit 14B-2, to determine the appropriate discount factor using tables. Required: 1. Calculate the payback period for each product 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. 6b. Based on the simple rate of return, which of the two products should Lou's division accept
