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Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one...

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Accounting

Lou Barlow, a divisional manager for Sage Company, has anopportunity to manufacture and sell one of two new products for afive-year period. His annual pay raises are determined by hisdivision’s return on investment (ROI), which has exceeded 22% eachof the last three years. He has computed the cost and revenueestimates for each product as follows:

Product AProduct B
Initial investment:
Cost of equipment (zero salvage value)$350,000$550,000
Annual revenues and costs:
Sales revenues$390,000$470,000
Variable expenses$178,000$210,000
Depreciation expense$70,000$110,000
Fixed out-of-pocket operating costs$87,000$67,000

The company’s discount rate is 20%.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determinethe appropriate discount factor using tables.

Required:

1. Calculate the payback period for each product.

2. Calculate the net present value for each product.

3. Calculate the internal rate of return for each product.

4. Calculate the project profitability index for eachproduct.

Answer & Explanation Solved by verified expert
4.4 Ratings (1039 Votes)

Annual cash flows:
Product A ProductB
Sales revenue 390000 470000
Less: variable cost 178000 210000
Less: Out of pocket fixed cost 87000 67000
Annual cashflows 125000 193000
Payback period:
Initial investment 350000 550000
Divide: Annual Cashflows 125000 193000
Payback period: 2.8 2.85
Req 2.
Annual Cashflws 125000 193000
Annuity PVF at 20% for5yrs 2.99061 2.99061
Present value of Cashflows 373826.3 577187.73
Less: Intial Investment 350000 550000
NPV 23826.3 27187.73
Req 3.
Annual Cashflws 125000 193000
Annuity PVF at 23.05% for5yrs 2.80052
Annuity PVF at 22.25% for5yrs 2.8484
Present value of Cashflows 350065 549741.2
Less: Intial Investment 350000 550000
NPV 65 -258.8
IRR 23.05% 22.25%
Req 4.
Profitab ility Index:
Present value of inflows at 20% 373826.3 577187.73
Divide: Inintial Investment 350000 550000
Profitab ility Index: 1.07 1.05

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