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: |
|
|
|
|
|
| Sales revenues |
$ |
420,000 |
|
$ |
500,000 |
| Variable expenses |
$ |
190,000 |
|
$ |
222,000 |
| Depreciation expense |
$ |
54,000 |
|
$ |
96,000 |
| Fixed out-of-pocket operating costs |
$ |
90,000 |
|
$ |
70,000 |
|
The company's discount rate is 21%.
Exhibit 13B-1 and Exhibit 13B-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.)
2. Calculate the net present value for each product. (Round discount factor(s) to 3 decimal places.)
3. Calculate the internal rate of return for each product. (Round percentage answer to 1 decimal place. i.e. 0.1234 should be considered as 12.3% and Round discount factor(s) to 3 decimal places.)
4. Calculate the project profitability index for each product. (Round discount factor(s) to 3 decimal places. Round your answers to 2 decimal places.)
5. 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%.)
6a. For each measure, identify whether Product A or Product B is preferred.
6b. Based on the simple rate of return, Lou Barlow would likely:
Accept Product A
Accept Product B
Reject both products