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 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) $360,000 530,000 Annual revenues and costs: $ 510,000 $ 250,000 $ 106,000 65,000 $400,000 $180,000 $72,000 $ 85,000 Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs The company's discount rate is 19% Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor using tables. Required: 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product A Product B Payback period years years

Answer 1

Solution 1:

P R T U V X АА АВ 2 3 4 5 6 7 Computation of Annual cash inflows Payback period 8 Particulars Product A Product B Choose Numerator/Choose Denominator Payback Period Particulars 10 Initial Investment/Annual Cash inflows Payback Period 2.67Years Sales revenue $400,000 $510,000 $360,000/ Variable expenses Fixed Out of pocket operating Product A $180,000 $250,000 $135,000 11 12 Product B $530,000/ 2,72 Years $85.000 $65.000 $195,000 cost Annual cash infl ows $135,000 $195,000 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 Sheet26 (20) Sheet65 (7) Sheet60 (4) Sheet473 (3) Sheet890 Sheet894 Sheet864 et887 O

Solution 2:

А В C D E F G Н 2 Computation of NPV Product A Product B PV Factor Period Present Value Particulars Amount Amount Present Value (19%) Cash outflows: 1 $360,000 $360,000 $530,000 $530,000 7 Initial investment 0 8 $530,000 $360,000 Present Value of Cash outflows (A) 10 Cash Inflows 11 12 3.058 $135,000 $412,830 $195,000 Annual cash inflows $596,310 1-5 13 $596,310 $412,830 Present Value of Cash Inflows (B) 14 15 $52,830 $66,310 Net Present Value (NPV) (B-A) 16 17 18 Sheet65 (7) Sheet26 (20) Sheet60 (4) Sheet473 (3) Sheet890 Sheet894 Sheet864 et887

Solution 3:

P R S 51 52 Computation of IRR 53 Project A Project B 54 Period Cash flows Cash flows IRR IRR -$360,000 $135,000 $135,000 $135,000 $135,000 $135,000 -$530,000 $195,000 $195,000 $195,000 $195,000 $195,000 55 0 56 1 57 2 25.4% 24.5% 58 3 59 60 5 61 62 63 64 65 66 67 68 69 70 71 72 Sheet26 (20) Sheet65 (7) Sheet60 (4) Sheet473 (3) Sheet890 Sheet894 Sheet864 et887

Solutiin 4:

о P R S T U 20 21 22 23 24 25 26 27 28 Computation of Profitability Index 29 Product A Particulars Product B 30 $66,310 $530,000 $52,830 $360,000 Net present value Initial investment 31 32 33 Profitability Index (PV of cash inflows/Initial investment) 34 0.15 0.13 35 36 37 Sheet65 (7) Sheet26 (20) Sheet60 (4) Sheet473 (3) Sheet890 Sheet894 Sheet864 et887

Solution 5:

АC AD АЕ AF AG АН AI AJ 2 Computation of Annual Operating income 3 Particulars Product A Product B $195,000 Annual cash inflows $135,000 4 5 $106,000 $72,000 Less: depreciation $63,000 $89,000 Annual operating income 7 Simple rate of return Choose Simple rate / of return Particulars Choose Numerator Denominator Simple rate 10 Initial investment Annual operating income $63,000/ of return Product A $360,000 17.5% 11 12 $89,000/ Product B $530,000 16.8% 13 14 15 Sheet65 (7) Sheet26 (20) Sheet60 (4) Sheet473 (3) Sheet890 Sheet894 Sheet864 et887

Solution 6a:

P S R T 36 37 38 39 40 41 42 43 Product Preference 44 Net Present Value Product B 45 Profitability index Payback Period Product A 46 Product A 47 Product A 48 IRR Product A 49 Simple rate of Return 50 51 Sheet26 (20) Sheet65 (7) Sheet60 (4) Sheet473 (3) et887 Sheet890 Sheet894 Sheet864

Solutiin 6b:

Based on Simple rate of return, Lou Barlow would likely reject both projects as their Simple rate of return is less than Division's ROI (25%).