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 annual pay raises are determined by his division’s 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) $ 250,000 $ 460,000 Annual revenues and costs: Sales revenues $ 300,000 $ 400,000 Variable expenses $ 140,000 $ 190,000 Depreciation expense $ 50,000 $ 92,000 Fixed out-of-pocket operating costs $ 75,000 $ 55,000 The company’s discount rate is 18%. Use Excel or a financial calculator to solve any time value of money problems.

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 answers to the nearest dollar.)

3. Calculate the project profitability index for each product. (Round your answers to 2 decimal places.)

4. Calculate the simple rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3%.)

5a. For each measure, identify whether Product A or Product B is preferred.

5b. Based on the simple rate of return, Lou Barlow would likely: Accept Product A Accept Product B Reject both products

Answer 1