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 computed the following cost and revenue estimates for each product: Product A Product B Initial investment: Cost of equipment (zero salvage value) $ 380,000 $ 575,000 Annual revenues and costs: Sales revenues $ 410,000 $ 490,000 Variable expenses $ 186,000 $ 218,000 Depreciation expense $ 76,000 $ 115,000 Fixed out-of-pocket operating costs $ 89,000 $ 70,000 The company’s discount rate is 20%. Click here to view Exhibit 14B-1 and Exhibit 14B-2, to determine the appropriate discount factor(s) using tables. Required: 1. Calculate each product’s payback period. 2. Calculate each product’s net present value. 3. Calculate each product’s internal rate of return. 4. Calculate each product’s profitability index. 5. Calculate each product’s simple rate of return. 6a. For each measure, identify whether Product A or Product B is preferred. 6b. Based on the simple rate of return, which of the two products should Lou’s division accept?

10th Edition

ISBN:9781259964947

Author:Libby

Publisher:Libby

Chapter1: Financial Statements And Business Decisions

Section: Chapter Questions

Problem 1Q

	Product A	Product B
Initial investment:
Cost of equipment (zero salvage value)	$ 380,000	$ 575,000
Annual revenues and costs:
Sales revenues	$ 410,000	$ 490,000
Variable expenses	$ 186,000	$ 218,000
Depreciation expense	$ 76,000	$ 115,000
Fixed out-of-pocket operating costs	$ 89,000	$ 70,000