Question

2. Capital Budgeting Calculations. A divisional manager for a local company has an opportunity to manufacture and sell a new product for a five-year period. His annual pay raises are determined by his division's return on investment (ROI), which has exceeded 18% each of the last three years. The company's discount rate is 16%. He has computed the cost and revenue estimates for this potential product as follows: Initial Investment (cost of equipment) Sales Revenues Variable Expenses Depreciation Expense Fixed Out-of-Pocket Operating Costs * Assumes no salvage value $380,000 $350,000 $170,000 $76,000 $50.000 a. Calculate the payback period for this product. Round to the nearest whole year. b. Compute the accounting rate of return for this product.

Answer 1

Calculate the requirements as follows: A D E $ $ B Sales Less: Variable expenses Less: Fixed expenses Add: Depreciation Net annual cash flows Initial Investment Payback period (years) 3,50,000 1,70,000 50,000 76,000 2,06,000 3,80,000 $ $ $ Sales Less: Variable expenses Less: Fixed expenses Net Profit Initial Investment Accounting rate of return $ $ $ $ $ 3,50,000 1,70,000 50,000 1,30,000 3,80,000 34.21% or 34% Year 15 16 17 18 19 0 1-5 Cash flows -380000 $ 2,06,000 Net Present Value PVF @ 16% 1 3.27429 PV of Cash Flows -380000 $ 6,74,503.74 $ 2,94,503.74 or $294,504

Calculations: D E 1 A в a Sales Less: Variable expenses Less: Fixed expenses Add: Depreciation Net annual cash flows Initial Investment Payback period (years) 350000 170000 50000 76000 =C1-C2-C3+C4 380000 =C6/C5 5 6 7 9 b Sales 350000 10 Less: Variable expenses 170000 11 Less: Fixed expenses 50000 12 Net Profit =C9-C10-C11 Initial Investment 380000 14 Accounting rate of return =C12/C13 15 16 C Year Cash flows 17 lo -380000 18 1-5 Net Present Value or 34% PVF @ 16% PV of Cash Flows =C17*D17 =PV(16%,5,-1,0,0) =C18*3.27429 =E17+E18 or $294,504 =C5 19 lor $20