Question

Problem 11-19A Comprehensive Problem [LO11-1, LO11-2, LO11-3, LO11-4] 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 22% 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) $ 350,000 $ 550,000 Annual revenues and costs: Sales revenues $ 390,000 $ 470,000 Variable expenses $ 178,000 $ 210,000 Depreciation expense $ 70,000 $ 110,000 Fixed out-of-pocket operating costs $ 87,000 $ 67,000 The company’s discount rate is 20%. Click here to view Exhibit 11B-1 and Exhibit 11B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) 2. Calculate the net present value for each product. (Use the appropriate table to determine the discount factor(s).) 3. Calculate the project profitability index for each product. (Use the appropriate table to determine the discount factor(s). Round your answers to 2 decimal places.) 4. Calculate the simple rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and use the appropriate table to determine the discount factor(s).) 5a. For each measure, identify whether Product A or Product B is preferred. 5b. Based on the simple rate of return, Lou Barlow would likely: Accept Product A Accept Product B Reject both products

Answer 1

Answer to Part 1.: Sales Revenue Variable Expenses Product A 390000 178000 Product B 470000 210000 Fixed Out-of Pocket Expenses Operating Cash Flow 87000 125000 67000 193000 Payback Period Init ial Investment/Operating Cash Flow Project A Payback Period 350,000 125,000 Payback Period 2.80 years Project B Payback Period 550,000 193,000 Payback Period 2.85 years Answer to Part 2 Product A 350000 125000 2.9906 373825.00 23825.00 Year 0 1-5 Initial Cash Flow Operating Cash Flow PVIFA (22%, 3 years PV of Cash Inflow NPV Product B 550000 193000 2.9906 577185.80 27185.80

Answer to Part 3 Profitability Index - Pv of Cash Inflow/ PV of Cash Outflow Project A Profitability Index 373,825 /350,000 Profitability Index 1.07 Project B Profitability Index 577,185.80/550,000 Profitability Index 1.05 Answer to Part 4 Product A 125000 70000 Product B 193000 110000 Annual Cash Inflow Depreciation Expense Annual Incremental Net Operating Income Initial Investment Simple Rate of Return (%) 195000 350000 55.71 303000 550000 55.09 Simple Rate of ReturnAnnual Incremetal Net Operating Income/Initial Investment 100