Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products f ve-year period. His annual pay raises are determined by his division's return on investment (ROI), which has exceeded 18% each of st three years. He has computed the cost and revenue estimates for each product as follows: Product A Initial investment: Cost of equipment (zero salvage value) $170,000 Annual revenues and costs: Product B $380,000
Lou Barlow, a divisional manager for Sage Company, has an opportunity to manufacture and sell one of two new products f ve-year period. His annual pay raises are determined by his division's return on investment (ROI), which has exceeded 18% each of st three years. He has computed the cost and revenue estimates for each product as follows: Product A Initial investment: Cost of equipment (zero salvage value) $170,000 Annual revenues and costs: Product B $380,000
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
Related questions
Question
Solve:
1. Calculate the profitability index for each product.
2. Calculate the simple
3. Which of the two products should Lou's division pursue.
Transcribed Image Text: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 18% 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) | $170,000 | $380,000 |
| **Annual revenues and costs:** | | |
| Sales revenues | $250,000 | $350,000 |
| Variable expenses | $120,000 | $170,000 |
| Depreciation expense | $34,000 | $76,000 |
| Fixed out-of-pocket operating costs | $70,000 | $50,000 |
The company’s discount rate is 16%.
Expert Solution
Step 1: Given:
Here,
| Product A | Product B | |
| Cost of Equipment | $ 170,000.00 | $ 380,000.00 |
| Life of Equipment in years | 5 | 5 |
| Sales Revenues | $ 250,000.00 | $ 350,000.00 |
| Variable Expenses | $ 120,000.00 | $ 170,000.00 |
| Depreciation Expenses | $ 34,000.00 | $ 76,000.00 |
| Fixed Cost | $ 70,000.00 | $ 50,000.00 |
| Discount Rate | 16% | 16% |
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