Problem 11-19A Comprehensive Problem [LO11-1, LO11-2, LO11-3, LO11-4] Lou Barlow
ID: 2587439 • Letter: P
Question
Problem 11-19A Comprehensive Problem [LO11-1, LO11-2, LO11-3, LO11-4] 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: Product A Product B Initial investment: Cost of equipment (zero salvage value) Annual revenues and costs: Sales revenues Variable expenses Depreciation expense Fixed out-of-pocket operating costs $340,000 $540,000 $390,000 490,000 $176,000 $226,000 $ 68,000 108,000 $ 84,000 S 64,000 The company's discount rate is 18% Click here to view Exhibit 11B-1 and Exhibit 11B.-2, to determine the appropriate discount factor(s) using tables Required: 1. Calculate the payback period for each product. (Round your answers to 2 decimal places.) Product A Product B Payback period years yearsExplanation / Answer
Project A:
Initial Investment = $340,000
Useful Life = 5 years
Annual Cash flows = Sales Revenue - Variable Expenses - Fixed out-of-pocket Operating Costs
Annual Cash flows = $390,000 - $176,000 - $84,000
Annual Cash flows = $130,000
Project B:
Initial Investment = $540,000
Useful Life = 5 years
Annual Cash flows = Sales Revenue - Variable Expenses - Fixed out-of-pocket Operating Costs
Annual Cash flows = $490,000 - $226,000 - $64,000
Annual Cash flows = $200,000
Answer 1.
Project A:
Payback Period = Initial Investment / Annual Cash flows
Payback Period = $340,000 / $130,000
Payback Period = 2.62 years
Project B:
Payback Period = Initial Investment / Annual Cash flows
Payback Period = $540,000 / $200,000
Payback Period = 2.70 years
Answer 2.
Project A:
Present Value of Annual Cash flows = $130,000 * PV of an Annuity of $1 (18%, 5)
Present Value of Annual Cash flows = $130,000 * 3.127
Present Value of Annual Cash flows = $406,510
Net Present Value = Present Value of Annual Cash flows - Initial Investment
Net Present Value = $406,510 - $340,000
Net Present Value = $66,510
Project B:
Present Value of Annual Cash flows = $200,000 * PV of an Annuity of $1 (18%, 5)
Present Value of Annual Cash flows = $200,000 * 3.127
Present Value of Annual Cash flows = $625,400
Net Present Value = Present Value of Annual Cash flows - Initial Investment
Net Present Value = $625,400 - $540,000
Net Present Value = $85,400
Answer 3.
Project A:
Present Value of Annual Cash flows = $406,510
Profitability Index = Present Value of Annual Cash flows / Initial Investment
Profitability Index = $406,510 / $340,000
Profitability Index = 1.20
Project B:
Present Value of Annual Cash flows = $625,400
Profitability Index = Present Value of Annual Cash flows / Initial Investment
Profitability Index = $625,400 / $540,000
Profitability Index = 1.16
Answer 4.
Project A:
Annual Net Income = Annual Cash flows - Depreciation
Annual Net Income = $130,000 - $68,000
Annual Net Income = $62,000
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $62,000 / $340,000
Simple Rate of Return = 18.24%
Project B:
Annual Net Income = Annual Cash flows - Depreciation
Annual Net Income = $200,000 - $108,000
Annual Net Income = $92,000
Simple Rate of Return = Annual Net Income / Initial Investment
Simple Rate of Return = $92,000 / $540,000
Simple Rate of Return = 17.04%
Answer 5a.
Net Present Value = Product B
Profitability Index = Product A
Payback Period = Product A