Question

In: Accounting

Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one...

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 23% 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) $ 300,000 $ 500,000
  Annual revenues and costs:
  Sales revenues $ 350,000 $ 450,000
  Variable expenses $ 160,000 $ 210,000
  Depreciation expense $ 44,000 $ 86,000
  Fixed out-of-pocket operating costs $ 80,000 $ 61,000

  

The company’s discount rate is 16%.

  

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

Solutions

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