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:
Initial investment:
|
|
Product A |
|
|
Product B |
| 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 |
$ |
51,000 |
|
$ |
93,000 |
| Fixed out-of-pocket operating costs |
$ |
87,000 |
|
$ |
67,000
|
The company's discount rate is 20%.
1. Calculate the internal rate of return for each product.
2. Calculate the project profitability index for each product.
3. Calculate the simple rate of return for each product.