Question

Chapter 12 problem 1 (please help with 1, 5 and 6A). the rest I have figured out.

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)	$	290,000		$	490,000
Annual revenues and costs:
Sales revenues	$	340,000		$	440,000
Variable expenses	$	154,000		$	206,000
Depreciation expense	$	58,000		$	98,000
Fixed out-of-pocket operating costs	$	79,000		$	59,000

The company’s discount rate is 15%.

Required:

1. Calculate the payback period for each product.

2. done

3. done

4. done

5. Calculate the simple rate of return for each product.

6a. For each measure, identify whether Product A or Product B is preferred.

6b. done

Answer 1

1. Payback Period Calculation

		A	B
Initial Investment		2,90,000	4,90,000
Annual Revenue
Sales Revenue		340000	440000
Variable Expenses		154000	206000
Depreciation Expenses		58000	98000
Fixed Out of pocket		79000	59000
Cash Flows	1st Year	49000	77000
	2nd Year	60270	94710
	3rd Year	74132.1	116493.3
	4th Year	91182.48	143286.8
	5th year	112154.5	176242.7

Cummulative Cash Table	A	Cummulative Cash flow	B	Cummulative Cash flow
1st Year	49000	49000	77000	77000
2nd Year	60270	109270	94710	171710
3rd Year	74132.1	183402	116493	288203
4th Year	91182.48	274585	143287	431490
5th year	112154.5	386739.0371	176243	607733

Machine A

The Investment made in Machine A is $2,90,000

the amount repaid in 4 years is 274585

Pay Back Period = 4 years + (2,90,000 - 274585 ) / 112154 *12 = 4 years and 2 months

Machine B

The Investment made in Machine A is $4,90,000

the amount repaid in 4 years is 431490

Pay Back Period = 4 years + (4,90,000 - 431490 ) / 176242 *12 = 4 years and 4 months

5) Simple Rate of Return

Calculation simple rate of return
Particulars:	Product A	Product B
Sales revenues	$340,000	$440,000
Less: Variable expenses	$154,000	$206,000
Less: Depreciation expense	$58,000	$98,000
Less: Fixed out-of-pocket operating costs	$79,000	$59,000
Earnings before interest and taxes (A)	$49,000	$77,000
Investment in Equipment (B)	$290,000	$490,000
Rate of Return (A/B x 100)	16.90%	15.71%

6a ) Product A is prefered as the payback period is 4 years and 2 months and the ROR is 16.90 % which is better than product B.