Problem 13-23 Comprehensive Problem (LO13-1, LO13-2, LO13-3, LO13-5, LO13-6] Lou
ID: 2529917 • 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 25% each of the last three years. He has computed the cost and revenue estimates for each product as follows: 1.41/3 points awarded Product A Product B Scored $ 340,000 $ 525,000 Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $ 388,800 $ 172,000 $ 68,000 $ 83.000 $ 488,888 5 225,000 105.990 $ 66,888 eBook The company's discount rate is 17%. Print Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor using tables, References 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:Explanation / Answer
Calculation of Net Cash inflow & Operating Profit Product A Product B Sales Revenues 380,000 480,000 Less: Variable Expenses (172,000) (225,000) Less: Fixed out of Pocket Exp. (83,000) (66,000) Net Cash inflow 125,000 189,000 Less: Dep. (68,000) (105,000) Net Operating Income 57,000 84,000 Answer 1. Payback period = Intial investment / Cash Inflow per period Calculation of Pay Back Period Product A Product B Intial Investment (A) 340,000 525,000 Cash Inflow per Annum (B) 125,000 189,000 Pay Back Period (A/B) 2.72 Years 2.78 Years Answer 2. Calculation of NPV of Project Particulars Year 17% Factor Product A Product B Amount Present value Amount Present value C D C X D E C X E Cash Inflow Net Cash Inflow 1 -5 3.19935 125,000 399,919 189,000 604,677 A. Total Cash Inflow - PV 399,919 604,677 Cash Outflow Cost of Investment 0 1.00000 340,000 340,000 525,000 525,000.0000 B. Total Cash Outflow - PV 340,000 525,000 NPV (A - B) 59,919 79,677 Answer 3. Year Project A Project B Intial Investment 0 (340,000) (525,000) Expcted Net Cash inflow 1 125,000 189,000 2 125,000 189,000 3 125,000 189,000 4 125,000 189,000 5 125,000 189,000 Internal Rate of Return 24.45% 23.44% Answer 4. Project Profitability Index = NPV / Intial Investment Project A Project B NPV (A) 59,919 79,677 Intial investment (B) 340,000 525,000 Project Profitability Index (A/B) 0.18 0.15 Answer 5. Simple Rate of Return = Average Accounting Profit / Intial Investment Project A Project B Net operating profit (A) 57,000 84,000 Intial Investment (B) 340,000 525,000 Simple Rate of Return (A/B) 16.76% 16.00% Answer 6a. Net Present Value Profitability Index Payback Period Internal Rate of Return Project B Project A Project A Project A Answer 6b. Reject Both Project Since, Simple rate of return is Less then the Expected rate of return (19%)