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:

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 | $ | 68,000 | |

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.

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:

Answer #1

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)
$
340,000
$
540,000
Annual revenues and costs:...

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 22% 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)
$
380,000
$
575,000
Annual revenues and...

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)
$
260,000
$
480,000
Annual revenues and...

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 20% 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)
$
260,000
$
470,000
Annual revenues and...

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)
$
180,000
$
390,000
Annual revenues and
costs:...

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)
$
360,000
$
530,000
Annual revenues and...

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. 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)
$
210,000
$
420,000
Annual revenues and costs:
Sales revenues
$
290,000
$
390,000
Variable expenses
$
138,000
$
186,000
Depreciation expense
$
42,000
$
84,000
Fixed out-of-pocket operating costs
$...

Exercise 13-9 Net Present Value Analysis and Simple Rate of
Return [LO13-2, LO13-6]
Derrick Iverson is a divisional manager for Holston Company. His
annual pay raises are largely determined by his division’s return
on investment (ROI), which has been above 20% each of the last
three years. Derrick is considering a capital budgeting project
that would require a $3,560,000 investment in equipment with a
useful life of five years and no salvage value. Holston Company’s
discount rate is 16%. The...

Problem 13-18 Net Present Value Analysis [LO13-2]
Oakmont Company has an opportunity to manufacture and sell a new
product for a four-year period. The company’s discount rate is 16%.
After careful study, Oakmont estimated the following costs and
revenues for the new product:
Cost of equipment needed
$
170,000
Working capital needed
$
68,000
Overhaul of the equipment in year two
$
12,000
Salvage value of the equipment in four years
$
16,000
Annual revenues and costs:
Sales revenues
$...

Problem 13-18 Net Present Value Analysis [LO13-2]
Oakmont Company has an opportunity to manufacture and sell a new
product for a four-year period. The company’s discount rate is 17%.
After careful study, Oakmont estimated the following costs and
revenues for the new product:
Cost of equipment needed
$
165,000
Working capital needed
$
67,000
Overhaul of the equipment in year two
$
10,000
Salvage value of the equipment in four years
$
13,000
Annual revenues and costs:
Sales revenues
$...

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