Question

human res

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 5390,000 $585,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $420,000 $190,000 $ 78,000 $ 90,000 $500,000 $ 222,000 $ 117,000 $70,000 The company's discount rate is 21%

Answer 1

Solution 1:

Computation of Annual cash inflows
Particulars	Product A	Product B
Sales revenue	$420,000.00	$500,000.00
Variable expenses	$190,000.00	$222,000.00
Fixed Out of pocket operating cost	$90,000.00	$70,000.00
Annual cash inflows	$140,000.00	$208,000.00

Payback period
Particulars	Choose Numerator	/	Choose Denominator	=	Payback Period
	Initial Investment	/	Annual Cash inflows	=	Payback Period
Product A	$390,000.00	/	$140,000.00	=	2.79	Years
Product B	$585,000.00	/	$208,000.00	=	2.81	Years

Solution 2:

Computation of NPV
			Product A		Product B
Particulars	Period	PV Factor	Amount	Present Value	Amount	Present Value
Cash outflows:
Initial investment	0	1	$390,000	$390,000	$585,000	$585,000
Present Value of Cash outflows (A)				$390,000		$585,000
Cash Inflows
Annual cash inflows	1-5	2.926	$140,000	$409,640	$208,000	$608,608
Present Value of Cash Inflows (B)				$409,640		$608,608
Net Present Value (NPV) (B-A)				$19,640		$23,608

Solution 3:

Computation of Profitability Index
Particulars	Product A	Product B
NPV	$19,640	$23,608
Initial investment	$390,000	$585,000
Profitability Index (PV of cash inflows / Initial investment)	0.05	0.04

Solution 4:

Computation of Annual Operating income
Particulars	Product A	Product B
Annual cash inflows	$140,000.00	$208,000.00
Less: depreciation	$78,000.00	$117,000.00
Annual operating income	$62,000.00	$91,000.00

Simple rate of return
Particulars	Choose Numerator	/	Choose Denominator	=	Simple rate of return
	Annual operating income	/	Initial investment	=	Simple rate of return
Product A	$62,000.00	/	$390,000.00	=	15.9%
Product B	$91,000.00	/	$585,000.00	=	15.6%

Solution 5a:

Product Preference
Payback Period	Product A
Net Present Value	Product B
Profitability index	Product A

Solution 5b:

Based on simple rate of return, lou barlow would likely to reject both the products as it will decrease overall ROI of the division.