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 17% 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)$ 176,600$ 390,000Annual revenues and costs: Sales revenues$ 260,000$ 360,000Variable expenses$ 124,000$ 174,000Depreciation expense$ 36,000$ 78,000Fixed out-of-pocket operating costs$ 71,000$ 50,000 The company’s discount rate is 15%. Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor using tables. 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 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, which of the two products should Lou’s division accept? **EXHIBIT 12B-1***Present Value of $1 (Formula: $ \frac{1}{(1 + r)^n} $)*This table provides the present value of $1 for various interest rates and periods. It is useful for discounting future cash flows to present value terms.**Table Details:**- **Columns**: Represent interest rates ranging from 4% to 25%.- **Rows**: Represent periods from 1 to 40.For each period and interest rate combination, the table lists the present value factor. Multiply this factor by any future cash flow to find its present value.### Example Entries:- **Period 1**: - 4%: 0.962 - 5%: 0.952 - 10%: 0.909- **Period 10**: - 8%: 0.463 - 12%: 0.322 - 15%: 0.247### Understanding the Table:- As the period increases, the present value factor decreases for a given interest rate.- For higher interest rates, the present value factors are lower, indicating more significant discounting of future cash flows.This table aids in financial education by illustrating how future values are converted to present terms based on time and interest rate, facilitating informed financial decision-making. **EXHIBIT 12B-2: Present Value of an Annuity of $1 in Arrears**The table displays the present value of an annuity of $1 paid in arrears, calculated using the formula:\[ \frac{1/r(1-(1+r)^{-n})} \]Where:- $ r $ is the interest rate per period.- $ n $ is the number of periods.**Structure of the Table:**- **Columns:** Represent different interest rates, ranging from 4% to 25%.- **Rows:** Represent the number of periods, from 1 to 40.For example:- In the first row, the value 0.962 represents the present value of an annuity of $1 for 1 period at a 4% interest rate.- In the sixth column of the first row, 0.917 represents the value for a 9% interest rate for 1 period.- In the last column of the last row, 3.993 corresponds to the present value at a 25% interest rate for 40 periods.The table helps in calculating how much a series of future $1 payments is worth today, based on different interest rates and time periods, aiding in financial planning and analysis.

Capital Budgeting refers to the process of evaluating the various capital investments based on their…

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 17% 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) $ 176,600 $ 390,000 Annual revenues and costs: Sales revenues $ 260,000 $ 360,000 Variable expenses $ 124,000 $ 174,000 Depreciation expense $ 36,000 $ 78,000 Fixed out-of-pocket operating costs $ 71,000 $ 50,000 The company’s discount rate is 15%. Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor using tables. 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 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, which of the two products should Lou’s division accept?

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

	Product A	Product B
Initial investment:
Cost of equipment (zero salvage value)	$ 176,600	$ 390,000
Annual revenues and costs:
Sales revenues	$ 260,000	$ 360,000
Variable expenses	$ 124,000	$ 174,000
Depreciation expense	$ 36,000	$ 78,000
Fixed out-of-pocket operating costs	$ 71,000	$ 50,000