Question

Problem 13-23 Comprehensive Problem [LO13-1, LO13-2, LO13-3, LO13-5, LO13-6]

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 18% 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)	$	170,000		$	380,000
Annual revenues and costs:
Sales revenues	$	250,000		$	350,000
Variable expenses	$	120,000		$	170,000
Depreciation expense	$	34,000		$	76,000
Fixed out-of-pocket operating costs	$	70,000		$	50,000

  

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 three 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 three 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

rev: 11_22_2014_QC_59795, 03_16_2

Answer 1

Product A: Initial Investment = $170000
Annual cash inflow = 250000 - 120000 - 70000 = 60000

Product B: Initial Investment = $380000
Annual cash inflow = 350000 - 170000 - 50000 = 130000