# Capital Budgeting.pdf - Comprehensive Problem Lou Barlow a...

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1 Comprehensive Problem 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 19% 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) \$ 190,000 \$ 400,000 Annual revenues and costs: Sales revenues \$ 270,000 \$ 370,000 Variable expenses \$ 128,000 \$ 178,000 Depreciation expense \$ 38,000 \$ 80,000 Fixed out-of-pocket operating costs \$ 72,000 \$ 52,000 The company’s discount rate is 17%. 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:
2 Internal Rate of Return and Net Present Value Henrie’s Drapery Service is investigating the purchase of a new machine for cleaning and blocking drapes. The machine would cost \$137,320, including freight and installation. Henrie’s estimated the new machine would increase the company’s cash inflows, net of expenses, by \$40,000 per year. The machine would have a five-year useful life and no salvage value. Click here to view Exhibit 13B-1 and Exhibit 13B-2 , to determine the appropriate discount factor(s) using table. Required: 1. What is the machine’s internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.) 2. Using a discount rate of 14%, what is the machine’s net present value? Interpret your results. 3. Suppose the new machine would increase the company’s annual cash inflows, net of expenses, by only \$34,390 per year. Under these conditions, what is the internal rate of return? (Round your answer to whole decimal place i.e. 0.123 should be considered as 12%.) Quip Corporation wants to purchase a new machine for \$285,000. Management predicts that the machine will produce sales of \$290,000 each year for the next 5 years. Expenses are expected to include direct materials, direct labor, and factory overhead (excluding depreciation) totaling \$89,000 per year. The firm uses straight-line depreciation with an assumed residual (salvage) value of \$50,000. Quip's combined income tax rate,

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