Answer:
1. Calculate the payback period for each product.
- A = 2.71 years, A is preferred
- B = 2.8 years
2. Calculate the net present value for each product.
- A = $60,349
- B = $83,001, B is preferred
3. Calculate the internal rate of return for each product.
- A = 25%, A is preferred
- B = 23%
4. Calculate the project profitability index for each product.
- A = 121%, A is preferred
- B = 117%
5. Calculate the simple rate of return for each product.
- A = 184%, A is ´preferred
- B = 179%
6B. Based on the simple rate of return, Lou Barlow would likely:
- 1. Accept Product A, since its IRR is 25% which exceeds the company's minimum ROI (23%)
Explanation:
Product A Product B
Initial investment:
Cost of equipment $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
net cash flow $107,000 $175,000
The company's discount rate is 16%.
payback period
A = $290,000 / $107,000 = 2.71 years, A is preferred
B = $490,000 / $175,000 = 2.8 years
using an excel spreadsheet I calculated the NPV and IRR
NPV
A = $60,349
B = $83,001, B is preferred
IRR
A = 25%, A is preferred
B = 23%
Project profitability
A = $350,349 / $290,000 = 1.21
B = $573,001 / $490,000 = 1.17
Simple rate of return
A = $535,000 / $290,000 = 184%, A is ´preferred
B = $875,000 / $490,000 = 179%
