Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture
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: | |||
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Solution: Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture