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 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$51,000 $93,000
Fixed out-of-pocket operating costs$87,000 $67,000
The company’s discount rate is 20%.
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 3 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 3 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:
Accept Product A
Accept Product B
Reject both products