A Company Is Trying to Decide Which of Two New

question 116

Essay

A company is trying to decide which of two new product lines to introduce in the coming year. The predicted revenue and cost data for each product line follows:
$\begin{array} { l | l | l } \hline & \text { Product A } & \text { Product B } \\\hline \text { Sales } & \$ 80,000 & \$ 96,000 \\ \hline \text { Direct materials } & 3,000 & 6,000 \\\hline \text { Direct labor } & 30,000 & 45,000 \\\hline \text { Other cash operating expenses } & 7,500 & 9,000 \\\hline \text { New equipment costs }& 75,000 & 100,000 \\\hline \text { Estimated useful life (no salvage) }& 5 \text { years } & 5 \text { years }\end{array}$
The company has a 30% tax rate, it uses the straight-line depreciation method, and it predicts that cash flows will be spread evenly throughout each year. Calculate each product's payback period. If the company requires a payback period of three years or less, which, if either, product should be chosen?

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Definitions:

Boston Red Sox

An American professional baseball team based in Boston, Massachusetts, playing in Major League Baseball's American League East division.

Lowball Technique

Getting a commitment from a person and then raising the cost of that commitment.

Current Market Rate

The prevailing rate at which goods, services, or securities are bought and sold in the market at a given time.

Expensive Extra Equipment

High-cost additional pieces of hardware or accessories that are not essential for basic operation but may enhance functionality or experience.