Project A:
Initial Investment = $340,000
Net Income = Sales Revenues - Variable Expenses - Depreciation
Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $390,000 - $176,000 - $68,000 - $84,000
Annual Net Income = $62,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $62,000 + $68,000
Annual Net Cash flows = $130,000
Project B:
Initial Investment = $540,000
Net Income = Sales Revenues - Variable Expenses - Depreciation
Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $490,000 - $226,000 - $108,000 - $64,000
Annual Net Income = $92,000
Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $92,000 + $108,000
Annual Net Cash flows = $200,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Net Cash
flows
Payback Period = $340,000 / $130,000
Payback Period = 2.62 years
Project B:
Payback Period = Initial Investment / Annual Net Cash
flows
Payback Period = $540,000 / $200,000
Payback Period = 2.70 years
Answer 2.
Project A:
Net Present Value = -$340,000 + $130,000 * PVA of $1 (18%,
5)
Net Present Value = -$340,000 + $130,000 * 3.1272
Net Present Value = $66,536
Project B:
Net Present Value = -$540,000 + $200,000 * PVA of $1 (18%,
5)
Net Present Value = -$540,000 + $200,000 * 3.1272
Net Present Value = $85,440
Answer 3.
Product A:
Profitability Index = Net Present Value / Initial
Investment
Profitability Index = $66,536 / $340,000
Profitability Index = 0.20
Product B:
Profitability Index = Net Present Value / Initial
Investment
Profitability Index = $85,440 / $540,000
Profitability Index = 0.16
Answer 4.
Project A:
Simple Rate of Return = Annual Net Income / Initial
Investment
Simple Rate of Return = $62,000 / $340,000
Simple Rate of Return = 18.2%
Project B:
Simple Rate of Return = Annual Net Income / Initial
Investment
Simple Rate of Return = $92,000 / $540,000
Simple Rate of Return = 17.0%
Answer 5-a.
Net Present Value = Project B
Profitability Index = Project A
Payback Period = Project A
Answer 5-b.
Based on the simple rate of return, Lou Barlow would not accept any project as simple rate of return is lower than the return on investment.
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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 23% 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) $ 280,000 $ 480,000 Annual revenues and costs:...
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