In: Accounting
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 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 company’s discount rate is 20%.
Click here to view Exhibit 12B-1 and Exhibit 12B-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 project profitability index for each product.
Annual cash flows: | ||||||
Product A | ProductB | |||||
Sales revenue | 390000 | 470000 | ||||
Less: variable cost | 178000 | 210000 | ||||
Less: Out of pocket fixed cost | 87000 | 67000 | ||||
Annual cashflows | 125000 | 193000 | ||||
Payback period: | ||||||
Initial investment | 350000 | 550000 | ||||
Divide: Annual Cashflows | 125000 | 193000 | ||||
Payback period: | 2.8 | 2.85 | ||||
Req 2. | ||||||
Annual Cashflws | 125000 | 193000 | ||||
Annuity PVF at 20% for5yrs | 2.99061 | 2.99061 | ||||
Present value of Cashflows | 373826.3 | 577187.73 | ||||
Less: Intial Investment | 350000 | 550000 | ||||
NPV | 23826.3 | 27187.73 | ||||
Req 3. | ||||||
Annual Cashflws | 125000 | 193000 | ||||
Annuity PVF at 23.05% for5yrs | 2.80052 | |||||
Annuity PVF at 22.25% for5yrs | 2.8484 | |||||
Present value of Cashflows | 350065 | 549741.2 | ||||
Less: Intial Investment | 350000 | 550000 | ||||
NPV | 65 | -258.8 | ||||
IRR | 23.05% | 22.25% | ||||
Req 4. | ||||||
Profitab ility Index: | ||||||
Present value of inflows at 20% | 373826.3 | 577187.73 | ||||
Divide: Inintial Investment | 350000 | 550000 | ||||
Profitab ility Index: | 1.07 | 1.05 | ||||