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 20% each of the last three years. He has computed the cost and revenue estimates for each product as follows: Initial investment: Cost of equipment (zero salvage value) $ 260,000 $ 470,000 Annual revenues and costs: Sales revenues $ 310,000 $ 410,000 Variable expenses $ 144,000 $ 194,000 Depreciation expense $ 52,000 $ 94,000 Fixed out-of-pocket operating costs $ 76,000 $ 56,000 The company’s discount rate is 18%. 1. Calculate the payback period for each product. 2. Calculate the net present value for each product. 3. Calculate the project profitability index for each product. 4. Calculate the simple rate of return for each product.

Answer 1

products. Computing Net Income Guneared Particulars per annum for two Baduut - A $3101000 Bodud -B $410,000 $ 194,000 Ao Revenue uss: Veuiable cuprises in contribution $144,000 $1661000 $216,000 $52.000 $94.000 less: $5660 Depreciation Fired eupeuses. $76,000 $381000 $66,000 1. Pay Bauna pution of caute product: lukiul investment (²) not innome pe anmeme Product A- $269,000 (²) $36,000 = .: Deprevation is a now-cash cipuuse we shall not consider 'it :- in product A annual income - $90,000 Product B annual income - $360,000. 1. pay-Bank ProductA periods: - initial investment (8) Net Annual income $260,000 (²) $90,0000 - 2.88 years. (or) oct 2 years & 10.56 months Product B $470.000 (:) $160,000 - 2.938 years (or) dalost 2years 4 11.28 months.

I PN Year ( P.V. Factor ② Tuplow carlinklar Coutflow) P.V Couplow) ($701000) ($260.000) $44101000) ($470100 0.71870.8475 $763275 $1601000 $135,6000 0.7162 $90,000 $64 9638 $160,000 $114,912 o.b066 $901000 $54, 594 $160,000 $97,056 (9.5158 $90,000 $46,422 $160,000 $82,526 0.4371 $90,000 $39,339 $160,000 $69,936 NPV $21,260 NPV $30,032 3. Profitability Indeu:- Sum of discomited ceisk inflows initial cash out flow Prodent A $2819 268 = 1.082 (P.I) / desirability Factor $260.000 Product B- $5009032 = 1.064 (P. I) / Desirability Factor. $470.000 4. Simple Rate of Rawn of ecul product. simple Rate of Return / Accounting rate of return = Avuage Annual net income investmout Produut A $90,000 u $ 200.000 - s 6.34615 = 34.62% Product B $160,000 = 0.3404 = 34.04 % non
Depreciation is a non cash expense.

In investment decisions it is considered only to compute the net income after tax shield or tax benefit as depreciation is a tax deductible expense.

But here in this problem no tax rate has been mentioned thus it is assumed that the business is being functioning in a tax free environment.Thus depreciation is added back.