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 25% 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)	$	340,000		$	540,000
Annual revenues and costs:
Sales revenues	$	390,000		$	490,000
Variable expenses	$	176,000		$	226,000
Depreciation expense	$	68,000		$	108,000
Fixed out-of-pocket operating costs	$	84,000		$	64,000

The company’s discount rate is 18%.

  

Click here to view Exhibit 13B-1 and Exhibit 13B-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 answer 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 answer 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