Problem 13-23 Comprehensive Problem [LO13-1, LO13-2, LO13-3, LO13-5, LO13-6] Lou
ID: 2409528 • Letter: P
Question
Problem 13-23 Comprehensive Problem [LO13-1, LO13-2, LO13-3, LO13-5, LO13-6]
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 24% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
The company’s discount rate is 15%.
Click here to view Exhibit 13B-1 and Exhibit 13B-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 project profitability index for each product.
Calculate the payback period for each product. (Round your answers to 2 decimal places.)
Calculate the net present value for each product. (Round your final answers to the nearest whole dollar amount.)
Calculate the internal rate of return for each product. (Round your answers to 1 decimal place i.e. 0.123 should be considered as 12.3%.)
Calculate the project profitability index for each product. (Round your answers to 2 decimal places.)
Product A Product B Initial investment: Cost of equipment (zero salvage value) $ 330,000 $ 515,000 Annual revenues and costs: Sales revenues $ 370,000 $ 470,000 Variable expenses $ 168,000 $ 218,000 Depreciation expense $ 66,000 $ 103,000 Fixed out-of-pocket operating costs $ 82,000 $ 68,000Explanation / Answer
Answer
Answer
Calculation of Payback period Product A Product B Payback Period 2.75 years 3 years Calculation of Net Present Value of the products Year Discount Factor @ 15% Product A Product B Cashflow Present value of Cashflow Cashflow Present value of Cashflow 0 1 (330,000) (330,000) (515,000) (515,000) 1 0.8695 120,000 104,340 184,000 159,988 2 0.7561 120,000 90,732 184,000 139,122 3 0.6575 120,000 78,900 184,000 120,980 4 0.5717 120,000 68,604 184,000 105,193 5 0.4971 120,000 59,652 184,000 91,466 Net Present Value 72,228 101,750 Calculation of Internal Rate of Return of the products (IRR) Product A Product B IRR 23.62% 22.52% Calculation of Profitability Index Product A Product B NPV (calculated above) 72,228 101,750 Initial Investment 330,000 515,000 Profitability Index 0.22 0.20 Workings Calculation of Cashflows Product A Product B $ $ Sales Revenue 370,000 470,000 Less Variable Cost (168,000) (218,000) Less: Fixed Cost ( excluding depreciation) (82,000) (68,000) Net Cashflow 120,000 184,000 Payback Period = Initial Investment/ Annual Cashdlows Product A Product B Initial Investment 330,000 515,000 Annual Cash flow 120,000 184,000 Payback period 2.75 2.80 Calculation of NPV @ Highest Rate Year Discount Factor @ 25% Product A Product B Cashflow Present value of Cashflow Cashflow Present value of Cashflow 0 1 (330,000) (330,000) (515,000) (515,000) 1 0.8 120,000 96,000 184,000 147,200 2 0.64 120,000 76,800 184,000 117,760 3 0.512 120,000 61,440 184,000 94,208 4 0.4096 120,000 49,152 184,000 75,366 5 0.3276 120,000 39,312 184,000 60,278 Net Present Value (7,296) (20,187) Calculation of Internal Rate of Return of the products (IRR) IRR = L + ({NPV(L) / (NPV(L) - NPV(H))} X (H -L)) Where, L = Lower discount rate H = Higher discount rate NPV(L) NPV calculated @ lowest rate NPV(H) NPV calculated @ Highest rate For Product A, IRR = 10 + (72228/ 72228 - (-7296)) X (25 - 10) = 23.62% For Product B, IRR = 10 + (101750/ 101750 - (-20187)) X (25 - 10) = 22.52%