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 21% 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)	$	270,000		$	480,000
Annual revenues and costs:
Sales revenues	$	320,000		$	420,000
Variable expenses	$	148,000		$	198,000
Depreciation expense	$	54,000		$	96,000
Fixed out-of-pocket operating costs	$	77,000		$	57,000

The company’s discount rate is 19%.

3.	Calculate the project profitability index for each product. (Use the appropriate table to determine the discount factor(s). Round your answers to 2 decimal places.)

  

	Product A	Product B
Simple Rate of Return	____________%	______________%

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% and use the appropriate table to determine the discount factor(s).) Net Present Value Profitability Index Payback Period ____________ _______________ ______________

     

Answer 1

Annual Inflows and net income
			Product A	Product B
Sales revenue			320000	420000
Less: Variable expense			148000	198000
Less: Fixed out of pocket expense			77000	57000
Annual Inflows			95000	165000
Less: Depreciation			54000	96000
Annual Net Income			41000	69000
Average Investment			135000	240000
Simple rate of return:
			ProductA	Product B
Annual net income			41000	69000
Divide: Average Investment			135000	240000
Simple rate of return			30.37%	28.75%
Payback period:
			Product A	Product B
Initial Investment			270000	480000
Divide: Annual Inflows			95000	165000
Payback periiod			2.84	2.91
NPV:
			Product A	Product B
Annual Inflows			95000	165000
Annuity present value			3.0576	3.0576
Present value of inflows			290472	504504
Less: Initial Investment			270000	480000
NPV			20472	24504
Profitability Index:
			Product A	Product B
Present value of inflows			290472	504504
Divide: Initial Investment			270000	480000
Profitability Index			1.076	1.051