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 24% 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) |
$ 330,000 |
$ 515,000 |
|---|
Annual revenues and costs: |
|
|
|---|
Sales revenues |
$ 370,000 |
$ 470,000 |
|---|
Variable expenses |
$ 168,000 |
$ 218,000 |
|---|
Depreciation expense |
$ 66,000 |
$ 103,000 |
|---|
Fixed out-of-pocket operating costs |
$ 82,000 |
$ 68,000 |
|---|
The company’s discount rate is 15%.
Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor using tables.
Required:
1. Calculate the payback period for each product.
|
Product A (Years)
|
Product B (Years)
|
Payback Period
|
|
|
2. Calculate the net present value for each product.
|
Product A
|
Product B
|
Net present value
|
|
|
3. Calculate the internal rate of return for each product.
|
Product A
|
Product B
|
Internal rate of return %
(Round to one decimal place) |
|
|
4. Calculate the profitability index for each product.
|
Product A
|
Product B
|
Profitability Index
|
|
|
5. Calculate the simple rate of return for each product.
|
Product A
|
Product B
|
Simple rate of return %
(Round to 1 decimal place) |
|
|
6a. For each measure, identify whether
Product A or Product B
is preferred.
Net present value
|
Profitability Index
|
Payback Period
|
Internal Rate of Return
|
Simple Rate of Return
|
|
|
|
|
|
6b. Based on the simple rate of return, which of the two products should Lou’s division accept? (Multiple Choice - Choose 1)
Accept Product A |
Accept Product B |
Reject both products |