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 23% 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)$290,000 $490,000Annual revenues and costs: Sales revenues$340,000 $440,000Variable expenses$154,000 $206,000Depreciation expense$58,000 $98,000Fixed out-of-pocket operating costs$79,000 $59,000 The company’s discount rate is 15%. Click here to view Exhibit 14B-1 and Exhibit 14B-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?

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Cornerstones of Cost Management (Cornerstones Series)

4th Edition

ISBN:9781305970663

Author:Don R. Hansen, Maryanne M. Mowen

Publisher:Don R. Hansen, Maryanne M. Mowen

Chapter18: Pricing And Profitability Analysis

Section: Chapter Questions

Problem 36P: Dantrell Palmer has just been appointed manager of Kirchner Glass Products Division. He has two...

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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 23% 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)	$	290,000	$	490,000
Annual revenues and costs:
Sales revenues	$	340,000	$	440,000
Variable expenses	$	154,000	$	206,000
Depreciation expense	$	58,000	$	98,000
Fixed out-of-pocket operating costs	$	79,000	$	59,000

The company’s discount rate is 15%.

Click here to view Exhibit 14B-1 and Exhibit 14B-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?

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