Solved:
Answered by AI, Verified by Human Experts
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 18% each of the last three years. He has computed the cost and revenue estimates for each product as follows:
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 18% 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) $ 170,000 $ 380,000
Annual revenues and costs:
Sales revenues $ 250,000 $ 350,000
Variable expenses $ 120,000 $ 170,000
Depreciation expense $ 34,000 $ 76,000
Fixed out-of-pocket operating costs $ 70,000 $ 50,000
The company?s discount rate is 16%.
Required:
1. Calculate the payback period for each product.
The payback period for Product A is approximately 6.54 years, and for Product B, it is approximately 7.04 years. This period represents how long it will take to recover the initial investment from the net annual cash inflow.To calculate the payback period for each product, one must identify the time it takes for the initial investment to be recovered through the net cash inflows from the investment. This is done by dividing the initial investment by the annual net cash inflow, which is sales revenue minus variable expenses, fixed costs, and depreciation (since depreciation is a non-cash charge).For Product A:Initial investment: $170,000Annual net cash inflow = Sales revenues - Variable expenses - Fixed costs - Depreciation = $250,000 - $120,000 - $70,000 - $34,000 = $26,000Payback period = Initial investment \/ Annual net cash inflow = $170,000 \/ $26,000 ≈ 6.54 yearsFor Product B:Initial investment: $380,000Annual net cash inflow = Sales revenues - Variable expenses - Fixed costs - Depreciation = $350,000 - $170,000 - $50,000 - $76,000 = $54,000Payback period = Initial investment \/ Annual net cash inflow = $380,000 \/ $54,000 ≈ 7.04 years...