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: Product $ 250,000 Product B $ 460,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $ $ $ $ 300,000 135,000 50,000 75,000 $ 400,000 $ 190,000 $ 92,000 $ 55,000 The company's discount rate is 18%. Click here to view Exhibit 128-1 and Exhibit 128-2, to determine the appropriate discount factor using tables. Required: 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 Complete this question by entering your answers in the tabs below. Reg 2 Reg 1 Req3 Reg 4 Req 6A Reg 5 Req 68 u formach product (Round your answer to 1 decimal place i.e. 0.123 should be considered

hi, can you please help me with required 1 through 6B. thanks and have a great day

Answer 1

Project A:

Initial Investment = $250,000

Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $300,000 - $135,000 - $50,000 - $75,000
Annual Net Income = $40,000

Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $40,000 + $50,000
Annual Net Cash flows = $90,000

Project B:

Initial Investment = $460,000

Net Income = Sales Revenues - Variable Expenses - Depreciation Expenses - Fixed out-of-pocket Operating Costs
Annual Net Income = $400,000 - $190,000 - $92,000 - $55,000
Annual Net Income = $63,000

Annual Net Cash flows = Annual Net Income + Depreciation
Annual Net Cash flows = $63,000 + $92,000
Annual Net Cash flows = $155,000

Answer 1.

Project A:

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $250,000 / $90,000
Payback Period = 2.78 years

Project B:

Payback Period = Initial Investment / Annual Net Cash flows
Payback Period = $460,000 / $155,000
Payback Period = 2.97 years

Answer 2.

Project A:

Net Present Value = -$250,000 + $90,000 * PVA of $1 (18%, 5)
Net Present Value = -$250,000 + $90,000 * 3.127
Net Present Value = $31,430

Project B:

Net Present Value = -$460,000 + $155,000 * PVA of $1 (18%, 5)
Net Present Value = -$460,000 + $155,000 * 3.127
Net Present Value = $24,685

Answer 3.

Project A:

Let IRR be i%

$250,000 = $90,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.778
Using table values, i = 23.4%

So, IRR is 23.4%

Project B:

Let IRR be i%

$460,000 = $155,000 * PVA of $1 (i%, 5)
PVA of $1 (i%, 5) = 2.968
Using table values, i = 20.3%

So, IRR is 20.3%

Answer 4.

Product A:

Profitability Index = Net Present Value / Initial Investment
Profitability Index = $31,430 / $250,000
Profitability Index = 0.13

Product B:

Profitability Index = Net Present Value / Initial Investment
Profitability Index = $24,685 / $460,000
Profitability Index = 0.05

Answer 5.

Project A:

Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $40,000 / $250,000
Simple Rate of Return = 16.0%

Project B:

Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $63,000 / $460,000
Simple Rate of Return = 13.7%

Answer 6-a.

Net Present Value = Project B
Profitability Index = Project A    
Payback Period = Project A
Internal Rate of Return = Project A
Simple Rate of Return = Project A

Answer 6-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.