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 22% each of the last three years. He has computed the cost and revenue Estimates for each product as follows: Product Product B S380,000 $575.000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and cuests: Sales revenues Variable expenses Depreciation expense Fixed out of pocket operating costs $410,000 S188.000 S 78.000 S 89.000 $490.000 S 218.000 S 115.000 69.000 The company's discount rate is 20% Click here to view Exhibit 118-1 and Exhibit 118-2 to determine the appropriate discount factors) using Required: 1. Calculate the payback period for each product Round your answers to 2 decimal places.) Products yearst Product B years Payback period Calculate the not present value for each product. Use the appropriate table to determine the discount factore).) Product Product B Net present value 3. Calculate the project profitability index for each product Use the appropriate table to determine the discount factor(o). Round your answers to 2 decimal places) Product Product B Project profitability index 4. Calculate the simple rate of return for each product. Round percentage answer to 1 decimal place Le 0.1234 should be considered as 12.3% and use the appropriate table to determine the discount factor(s).) Product Product B Simple rate of return

Answer 1

Project A:

Initial Investment = $380,000

Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $410,000 - $186,000 - $76,000 - $89,000
Annual Net Income = $59,000

Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $59,000 + $76,000
Annual Net Cash flows = $135,000

Project B:

Initial Investment = $575,000

Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $490,000 - $218,000 - $115,000 - $69,000
Annual Net Income = $88,000

Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $88,000 + $115,000
Annual Net Cash flows = $203,000

Answer 1.

Project A:

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $380,000 / $135,000
Payback Period = 2.81 years

Project B:

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $575,000 / $203,000
Payback Period = 2.83 years

Answer 2.

Project A:

Net Present Value = -$380,000 + $135,000 * PVA of $1 (20%, 5)
Net Present Value = -$380,000 + $135,000 * 2.991
Net Present Value = $23,785

Project B:

Net Present Value = -$575,000 + $203,000 * PVA of $1 (20%, 5)
Net Present Value = -$575,000 + $203,000 * 2.991
Net Present Value = $32,173

Answer 3.

Product A:

Profitability Index = Net Present Value / Initial Investment
Profitability Index = $23,785 / $380,000
Profitability Index = 0.06

Product B:

Profitability Index = Net Present Value / Initial Investment
Profitability Index = $32,173 / $575,000
Profitability Index = 0.06

Answer 4.

Project A:

Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $59,000 / $380,000
Simple Rate of Return = 15.5%

Project B:

Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $88,000 / $575,000
Simple Rate of Return = 15.3%

Answer 5-a.

Net Present Value = Project B
Profitability Index = Project A or Project B           
Payback Period = Project A