Question

EXHIBIT 7B-1 Present Value of $1; (1) Periods 4% 5% 6% 7% 8% 9% 10% 11% 12% 13% 14% 15% 16% 17% 18% 19% 20% 21% 22% 23% 24% 25% 1 0.962 0.952 0.943 0.935 0.926 0.917 0.909 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833 0.826 0.820 0.813 0806 0.800 0.925 0.907 0.890 0.873 0.857 0.842 0.826 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694 0.683 0.672 0.661 0.650 0.640 2 3 0.889 0.864 0.840 0.816 0.794 0.772 0.751 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579 0.564 0.551 0.537 0524 0.512 4 0.855 0.823 0.792 0763 0.735 0.708 0683 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482 0.467 0.451 0437 0.423 0410 5 0.822 0.784 0.747 0713 0.681 0.650 0.621 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0402 0.386 0.370 0.355 0.341 0.328 6 0.790 0.746 0.705 0.666 0.630 0.596 0.564 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335 0.319 0.303 0.289 0275 0.262 7 0.760 0.711 0.665 0.623 0.583 0.547 0.513 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0279 0.263 0.249 0.235 0.222 0.210 8 0.731 0.677 0.627 0.582 0.540 0.502 0.467 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0266 0.249 0.233 0.218 0204 0191 0.179 0.168 0.703 0.645 0.592 0.544 0.500 0.460 0.424 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0225 0.209 0194 0.180 0167 0.155 0.144 0.134 0.107 10 0.676 0.614 0.558 0.508 0.463 0.422 0.386 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0191 0.176 0.162 0149 0137 0126 0116 11 0.650 0.585 0.527 0.475 0.429 0.388 0.350 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135 0123 0.112 0103 0.094 0.086 12 0.625 0.557 0.497 0.444 0.397 0.356 0.319 0.286 0.257 0.231 0.208 0187 0168 0.152 0137 0.124 0112 0102 0.092 0.083 0.076 0069 13 0.601 0.530 0.469 0.415 0.368 0.326 0.290 0.258 0.229 0.204 0.182 0163 0145 0130 0116 0.104 0.093 0.084 0.075 0.068 0.061 0.055 14 0.577 0.505 0.442 0.388 0.340 0.299 0.263 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078 0.069 0.062 0.055 0049 0.044 0.160 15 0.555 0481 0.417 0.362 0.315 0.275 0.239 0.209 0183 0.140 0123 0.108 0.095 0.084 0.074 0.065 0.057 0.051 0.045 0.040 0.035 16 0.534 0.458 0.394 0.339 0.292 0.252 0.218 0188 0.163 0141 0.123 0107 0.093 0.081 0.071 0.062 0.054 0.047 0.042 0.036 0.032 0.028 17 0.513 0.436 0.371 0.317 0.270 0.231 0198 0170 0146 0.125 0108 0.093 0.080 0.069 0.060 0.052 0.045 0.039 0.034 0030 0.026 0.023 18 0.494 0.416 0.350 0.296 0.250 0.212 0180 0153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038 0.032 0.028 0.024 0021 0.018 19 0.475 0.396 0.331 0.277 0.232 0194 0.164 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031 0.027 0.023 0.020 0.017 0.014 20 0.456 0.377 0.312 0.258 0.215 0.178 0149 0.124 0104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026 0.022 0.019 0.016 0.014 0.012 21 0.439 0.359 0.294 0.242 0.199 0.164 0.135 0.112 0.093 0.077 0.064 0.053 0.044 0.037 0.031 0.026 0.022 0.018 0.015 0.013 0.011 0.009 22 0.422 0.342 0.278 0.226 0.184 0150 0.123 0.101 0.083 0.068 0.056 0.046 0.038 0.032 0.026 0.022 0.018 0.015 0.013 0.011 0.009 0.007 23 0.406 0.326 0.262 0.211 0.170 0.138 0.112 0.091 0.074 0.060 0.049 0.040 0.033 0.027 0.022 0.018 0.015 0.012 0.010 0009 0.007 0.006 0.390 0.310 0.247 0197 24 0.158 0.126 0.102 0.082 0.066 0.053 0.043 0.035 0.028 0.023 0.019 0.015 0.013 0.010 0.008 0.007 0.006 0005 25 0.092 0.074 0.059 0.047 0.038 0.030 0.024 0.020 0.016 0.013 0.010 0.009 0.007 0.006 0.005 0.004 0.375 0.295 0.233 0.184 0146 0.116 26 0.361 0.281 0.220 0.172 0135 0.106 0.084 0.066 0.053 0.042 0.033 0.026 0.021 0.017 0.014 0.011 0.009 0.007 0.006 0.005 0.004 0.003 0.347 0.268 0.207 0.161 0125 27 0.098 0.076 0.060 0.047 0.037 0.029 0.023 0.018 0.014 0.011 0.009 0.007 0.006 0.005 0.004 0.003 0002 28 0.333 0.255 0.196 0.150 0.116 0.090 0.069 0.054 0.042 0.033 0.026 0.020 0.016 0.012 0.010 0.008 0.006 0.005 0.004 0.003 0.002 0.002 29 0.321 0.243 0.185 0141 0.107 0.082 0.063 0.048 0.037 0.029 0.022 0.017 0.014 0.011 0.008 0006 0.005 0.004 0.003 0.002 0.002 0.002 30 0.308 0.231 0.174 0131 0.099 0.075 0.057 0.044 0.033 0.026 0.020 0.015 0.012 0.009 0.007 0.005 0.004 0.003 0.003 0.002 0.002 0.001 40 0.208 0.142 0.097 0.067 0.046 0.032 0.022 0.015 0.011 0.008 0.005 0.004 0.003 0.002 0.001 0.001 0.001 0.000 0.000 0.000 0.000 0.000

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 17% 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)	$	180,000		$	390,000
Annual revenues and costs:
Sales revenues	$	260,000		$	360,000
Variable expenses	$	124,000		$	174,000
Depreciation expense	$	36,000		$	78,000
Fixed out-of-pocket operating costs	$	71,000		$	50,000

The company’s discount rate is 15%.

1. Calculate the payback period for each product.

2. Calculate the net present value for each product.

3. Calculate the internal rate of return for each product.

4. Calculate the project profitability index for each product.

5. Calculate the simple rate of return for each product.

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:

Answer 1

Project A Calculation of Net Cash Flows Variable Cost Year Sales Revenue Fixed Operating Cost $2,60,000.00 $2,60,000.00 $2,60,000.00 $2,60,000.00 $2,60,000.00 -$1,24,000.00 -$1,24,000.00 $1,24,000.00 $1,24,000.00 $1,24,000.00 -$71,000.00 $71,000.00 $71,000.00 $71,000.00 $71,000.00 Net Cash Flows d=a+b+c $65,000.00 $65,000.00 $65,000.00 $65,000.00 $65,000.00 Project B Calculation of Net Cash Flows Variable Cost Year Sales Revenue Fixed Operating Cost $3,60,000.00 $3,60,000.00 $3,60,000.00 $3,60,000.00 $3,60,000.00 min $1,74,000.00 $1,74,000.00 -$1,74,000.00 $1,74,000.00 $1,74,000.00 Net Cash Flows d=a+b+c $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $50,000.00 -$50,000.00 $50,000.00 $50,000.00 $50,000.00 1. Project Payback Period Project A Payback Period Formula = Initial Investment / Annual CashFlows Initial Investment Net CashFlows Payback period in Years) C-a/b $1,80,000.00 $65,000.00 2.8 Project B Payback Period Formula = Initial Investment / Annual CashFlows Initial Investment Net Cash Flows Payback Period (in Years) C-a/b $3,90,000.00 $1,36,000.00 2.9

2. Net Present Value Project A Years 1-5 Net Cash Inflows $65,000.00 $1,80,000.00 Annuity PV Factor @15% 3.352 Present Value of Annuity Investment Net Present Value Present Value $2,17,880.00 $1,80,000.00 $37,880.00 Project B Years 1-5 Net Cash Inflows $1,36,000.00 $3,90,000.00 Annuity PV Factor @15% 3.352 Present Value of Annuity Investment Net Present Value Present Value $4,55,872.00 $3,90,000.00 $65,872.00

3. IRR Project A Year Initial Investment Cash Inflows $1,80,000.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $65,000.00 $65,000.00 $65,000.00 $65,000.00 $65,000.00 IRR Net CashFlow d=(a+b+c) $1,80,000.00 $65,000.00 $65,000.00 $65,000.00 $65,000.00 $65,000.00 24% Project B Year Initial Investment Cash Inflows $3,90,000.00 $0.00 $0.00 $0.00 $0.00 $0.00 $0.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 IRR Net CashFlow d=(a+b+c) $3,90,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 $1,36,000.00 22%

4. Profitibility Index Project A Formula = Present Value of CashFlows / initial Investment Initial Investment Present Value of Cash Flows Profitibility Index $2,17,880.000 $1,80,000.000 са/ь 1.21 Project B Formula - Present Value of CashFlows / initial Investment Initial Investment Present Value of Cash Flows Profitibility Index C-a/b 1.17 $4,55,872.000 $3,90,000.000

5. Simple Rate of return Formula = (Incremental revenues - Incremental cost Including Depreciation / initial Investment)*100 Project A Calculation of Net Cash Flows Year Sales Revenue Variable Cost Depreciation Fixed Operating cost $2,60,000.00 $2,60,000.00 $2,60,000.00 $2,60,000.00 $2,60,000.00 m $1,24,000.00 $1,24,000.00 -$1,24,000.00 $1,24,000.00 $1,24,000.00 -$36,000.00 $36,000.00 $36,000.00 $36,000.00 $36,000.00 Net Cash Flows d=a+b+c $29,000.00 $29,000.00 $29,000.00 $29,000.00 $29,000.00 -$71,000.00 $71,000.00 -$71,000.00 $71,000.00 $71,000.00 in Project B Calculation of Net Cash Flows Variable Cost Year Sales Revenue Depreciation Fixed Operating Cost b $3,60,000.00 $3,60,000.00 $3,60,000.00 $3,60,000.00 $3,60,000.00 $1,74,000.00 -$1,74,000.00 -$1,74,000.00 $1,74,000.00 $1,74,000.00 $78,000.00 $78,000.00 $78,000.00 $78,000.00 $78,000.00 $50,000.00 $50,000.00 $50,000.00 $50,000.00 $50,000.00 Net Cash Flows d=a+b+c $58,000.00 $58,000.00 $58,000.00 $58,000.00 $58,000.00 Simple Rate of return Project A Incremental Cash Flows Initial Investment Simple rate of return $29,000.000 $1,80,000.000 16.11% Project A Incremental Cash Flows Initial Investment Simple rate of return $58,000.000 $3,90,000.000 14.87%

Preferred Project Payback Period NPV IRR Profitibility Index Project A 2.77 $37,880.000 23.59% 1. 21 Project B 2.87 $65,872.00 21.93% .17 | 1 А A Preferred Project Project A 16.11% Project B 14.87% Simple Rate of return Based on simple rate of return Lou Barlow would likely to prefer Project A

Formula for IRR Project A Year Initial Investment Cash Inflows -180000 65000 65000 65000 65000 65000 Net CashFlow d=(a+b+c) =B74+C74 =B75+C75 =B76+C76 =B77+C77 =B78+C78 =B79+C79 =IRR(D74:079) Project B Year Initial Investment Cash Inflows -390000 136000 136000 136000 136000 136000 Net CashFlow d=(a+b+c) =B85+C85 =B86+C86 =B87+C87 =B88+C88 =B89+C89 =B90+C90 =IRR(D85:D90) IRR