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 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 revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $320,000 $148,000 $ 54,000 $ 77,000 $420,000 $198,000 $ 96,000 $ 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. 4. Calculate the project profitability index for each product.

Answer 1

Solution 1:

Q R S S V W X z АА Computation of Annual cash inflows Payback period Particulars Product Product B Particulars Choose Numerator / Choose Denominator Payback Period 10 $320,000 $148,000 $420,000 $198,000 Initial Investment / Annual Cash inflows $270,000/ $95,000 Payback Period 2.84 Years Product A Sales revenue Variable expenses Fixed Out of pocket operating cost Annual cash inflows 12 Product B $480,000/ $165,000 2.91 Years $77,000 $95,000 $57,000 $165,000 13 23 24 25 20 et887 Sheet890 Sheet60 (4) Sheet26 (20) Sheet65 (7) Sheet894 Sheet473 (3) Sheet864

Solution 2:

B I co E Nm 7 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 $480,000 000 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 14 Present Value of Cash Inflows (B) $290,510 $504,570 Net Present Value (NPV) (B-A) $20,510 $24,570 16 17 18 19 et887 Sheet890 Sheet60 (4) Sheet26 (20) Sheet65 (7) Sheet894 Sheet473 (3) Sheet864

Solution 3:

R. S I U 50 51 52 Computation of IRR 53 54 Period IRR IRR 55 56 Project A Cash flows -$270,000 $95,000 $95,000 $95,000 $95,000 $95,000 Project B Cash flows -$480,000 $165,000 $165,000 $ 165,000 $165,000 $165,000 57 22.4% 21.3% 58 59 4 5 60 61 62 63 64 65 66 67 68 69 70 71 72 et887 Sheet890 Sheet60 (4) Sheet26 (20) Sheet65 (7) Sheet894 Sheet473 (3) Sheet864

Solution 4:

O р s 22 23 24 25 26 27 28 29 30 Computation of Profitability Index Particulars Product A Net present value $20,510 Initial investment $270,000 31 Product B $24,570 $480,000 32 Profitability Index (PV of cash inflows / Initial investment) 0.08 0.05 35 36 37 38 39 et887 Sheet890 Sheet60 (4) Sheet26 (20) Sheet65 (7) Sheet894 Sheet473 (3) Sheet864