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 21% 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) | $ | 270,000 | $ | 480,000 | |
Annual revenues and costs: | |||||
Sales revenues | $ | 320,000 | $ | 420,000 | |
Variable expenses | $ | 148,000 | $ | 198,000 | |
Depreciation expense | $ | 54,000 | $ | 96,000 | |
Fixed out-of-pocket operating costs | $ | 77,000 | $ | 57,000 | |
The company’s discount rate is 19%.
Click here to view Exhibit 13B-1 and Exhibit 13B-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.
Solution 1:
Computation of Annual cash inflows | ||
Particulars | Product A | Product B |
Sales revenue | $320,000.00 | $420,000.00 |
Variable expenses | $148,000.00 | $198,000.00 |
Fixed Out of pocket operating cost | $77,000.00 | $57,000.00 |
Annual cash inflows | $95,000.00 | $165,000.00 |
Payback period | ||||||
Particulars | Choose Numerator | / | Choose Denominator | = | Payback Period | |
Initial Investment | / | Annual Cash inflows | = | Payback Period | ||
Product A | $270,000.00 | / | $95,000.00 | = | 2.84 | Years |
Product B | $480,000.00 | / | $165,000.00 | = | 2.91 | Years |
Solution 2:
Computation of NPV | ||||||
Product A | Product B | |||||
Particulars | Period | PV Factor (19%) | Amount | Present Value | Amount | Present Value |
Cash outflows: | ||||||
Initial investment | 0 | 1 | $270,000 | $270,000 | $480,000 | $480,000 |
Present Value of Cash outflows (A) | $270,000 | $480,000 | ||||
Cash Inflows | ||||||
Annual cash inflows | 1-5 | 3.058 | $95,000 | $290,510 | $165,000 | $504,570 |
Present Value of Cash Inflows (B) | $290,510 | $504,570 | ||||
Net Present Value (NPV) (B-A) | $20,510 | $24,570 |
Solution 3:
Computation of IRR | ||||
Period | Product A | Product B | ||
Cash Flows | IRR | Cash Flows | IRR | |
0 | -$270,000.00 | 22.4% | -$480,000.00 | 21.3% |
1 | $95,000.00 | $165,000.00 | ||
2 | $95,000.00 | $165,000.00 | ||
3 | $95,000.00 | $165,000.00 | ||
4 | $95,000.00 | $165,000.00 | ||
5 | $95,000.00 | $165,000.00 |
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 ret...
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 21% each of the last three years. He has computed the cost and revenue estimates for each product as follows: Product A Product B $270,000 $480,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales...
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: ProductAProduct B Initial investment Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation...
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 21% each of the last three years. He has computed the cost and revenue estimates for each product as follows: Product A Product B $270,000 $480,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales...
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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 20% 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) $ 250,000 $ 460,000 Annual revenues and costs:...
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:...
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 25% 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) $ 340,000 $ 525,000 Annual revenues and costs:...
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 19% each of the last three years. He has computed the cost and revenue estimates for each product as follows: Product A Product B $ 190,000 $ 400,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and...
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) $ 390,000 $ 585,000 Annual revenues and costs:...
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 25% 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) $ 370,000 $ 530,000 Annual revenues and costs:...