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Homework answers / question archive / 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
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 AProduct BInitial investment:
Cost of equipment (zero salvage value) $300,000 $500,000
Annual revenues and costs:Sales revenues $350,000 $450,000
Variable expenses $160,000 $210,000
Depreciation expense $60,000 $100,000
Fixed out-of-pocket operating costs $80,000 $61,000
The company's discount rate is 16%.
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.
5. Calculate the simple rate of return for each product.
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:
1). Payback period for product A = 2.73 years
Payback period for product B = 2.79 years
2). NPV for product A = $60,172.30
NPV for product B = $86,098.56
3). IRR for product A = 24.32%
IRR for product B = 23.17%
4). Profitability index (PI) for product A = 1.20
Profitability index (PI) for product B = 1.17
If you ask net profitable index and answer shows wrong than you must subtract by 1 therefore net profitable index of product A = 1.20 - 1 = 0.20 and net profitable index of product B = 1.17 - 1 = 0.17
5). Simple rate of return for product A = 16.67%
Simple rate of return for product B = 15.80%
6-a). On the basis of payback period method the product A should be accepted because it has lower payback period than product B.
On the basis of NPV method the product B should be accepted because it has higher NPV than product A.
On the basis of IRR method the product A should be accepted because it has higher IRR than product B.
On the basis of PI method the product A should be accepted because it has higher PI than product B.
On the basis of simple rate of return the product A should be accepted because it has higher simple rate of return than product B.
6-b). Simple rate of return for Product A is 16.67% and Product B is 15.80%. The ROI of the division is 23%. Based on the simple rate of return, Lou Barlow would not accept any project as simple rate of return is lower than the return on investment. So, the Lou Barlow would reject both the products.
