Question

Posted this question yesterday but whoever answered it did not answer correctly. I am stuck on number 2; missing something but not sure what. Any help is appreciated.

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)	$	380,000		$	575,000
Annual revenues and costs:
Sales revenues	$	410,000		$	490,000
Variable expenses	$	186,000		$	218,000
Depreciation expense	$	76,000		$	115,000
Fixed out-of-pocket operating costs	$	89,000		$	69,000

The company’s 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

Answer 1

Annual Net Cash Flow :-

Particulars	A	B
Sales Revenues	$410000	$490000
Less : Variable Expense	($186000)	($218000)
Less : Fixed out of pocket operating cost	($89000)	($69000)
Annual Net Cash Flows	$135000	$203000

1) Payback Period of each product :-

Payback Period = Initial Cost / Annual Net Cash Flow

Product A = $380000 / $135000 = 2.81 Years

Product B = $5750000 / $203000 = 2.83 Years

Product A is Better than B, because Product A's Payback Period low then Product B' Payback Period.

2) Net Present Value of each product :-

Product A :-

Particulars	Net Cash Flow	PV Factor @ 20%	Present Value
Initial Cost	($380000)	1	($380000)
Year 1	$135000	0.833	$112455
Year 2	$135000	0.694	$93690
Year 3	$135000	0.579	$78165
Year 4	$135000	0.482	$65070
Year 5	$135000	0.402	$54270
		Net Present Value	$23650

Product B :-

Particulars	Net Cash Flow	PV Factor @ 20%	Present Value
Initial Cost	($575000)	1	($575000)
Year 1	$203000	0.833	$169099
Year 2	$203000	0.694	$140882
Year 3	$203000	0.579	$117537
Year 4	$203000	0.482	$97846
Year 5	$203000	0.402	$81606
		Net Present Value	$31970

Product B is Better than Product A, because B's Net Present Value high then A.

3) IRR :-

Product A = 22.809%

Product B = 22.513%

I Calculate IRR in Excel.

Product A is Better than Product B.

4) Profitability Index :-

Profitability Index = Total Present Value / Initial Cost

Product A :-

Particulars	Net Cash Flow	PV Factor @ 20%	Present Value
Year 1	$135000	0.833	$112455
Year 2	$135000	0.694	$93690
Year 3	$135000	0.579	$78165
Year 4	$135000	0.482	$65070
Year 5	$135000	0.402	$54270
		Total Present Value	$403650

= $403650 / $380000 = 1.06 times.

Product B :-

Particulars	Net Cash Flow	PV Factor @ 20%	Present Value
Year 1	$203000	0.833	$169099
Year 2	$203000	0.694	$140882
Year 3	$203000	0.579	$117537
Year 4	$203000	0.482	$97846
Year 5	$203000	0.402	$81606
		Total Present Value	$606970

= $606970 / $575000 = 1.056 times.

5) Simple Rate of Return :-

Particulars	Product A	Product B
Annual Net Cash Flow (from above)	$135000	$203000
Less : Depreciation Exp.	($76000)	($115000)
Annual Net Operating Income (a)	$59000	$88000
Cost of Investment (b)	$380000	$575000
Simple Rate of Return (a/b)*100	15.53%	15.30%

6(a)

Measure	Product Preferred
Payback Period	A
Net Present Value	B
Internal Rate of Return (IRR)	A
Profitability Index	A
Simple Rate of Return	A