Calculate the payback period of polo shirts. In other words, how many years will it take for the company to recoup the initial investment? Today's Cash Outflows Future Net Cash Flows Initial investment $1,500,000 Year 1 $425,000 Year 2 $425,000 Year 3 $425,000 Year 4 $425,000 Year 5 $425,000 The Scenario: You work in the product development department of an athletic apparel company. Your company has decided to add a new product and is choosing between a polo tee, yoga pants, or running shoes. You have been asked to evaluate the financial profitability of each option. You have estimated that the company has $1,500,000 to invest in the project, and each product has the potential to bring in an estimated $2,125,000 of future cash flows, although the timing of the cash flows varies per product. Additionally, two of the products would use equipment that could be sold at the end of the project cycle. In order to pay for the project, the company will have to finance at a 6% interest rate. Present value discount factors are listed as follows: Years 1 2345 PV of 1 at 6% 0.94340 PV of an Annuity at 6% 0.94340 0.89000 1.83339 0.83962 2.67301 0.79209 3.46511 0.74726 4.21236 Formulas: NPV = PV of total future net CF's - initial cost annual net CF's Payback period = cost of investment (for same CF's) Requirements 1. Calculate the profitability of each project using The payback method Net present value (NPV) 2. Make a decision on which product to produce by answering the Pause and Reflect questions on page 5. Today's Cash Outflows Initial investment Option 2: Yoga Pants $1,500,000 Future Net Cash Flows Year 1 $531,250 Year 2 $531,250 Year 3 $531,250 Year 4 $531,250 Salvage Value of Equipment $25,000 3. Calculate the payback period of yoga pants. Because the equipment will be sold in the 4th year, the cash flows for each year will not be the same (they are the same for years 1-3, but not for year 4). Use the following setup to calculate the payback period for a project with unequal cash flows: Year 1 234 Annual Net Cash Flow Cumulative Net Cash Flows 4. Calculate the NPV of polo shirts. a) Notice that for all four years the company will receive the same cash flow provided by the product. Use the PV of an annuity discount factor for this part of the calculation. b) Notice also that the company will sell equipment in the 4th year for an additional cash flow. Which present value table should you use when calculating a single sum? Add this amount to the PV found in part a) to determine the PV of total net cash flows. Option 3: Running Shoes Today's Cash Outflows Initial investment $1,500,000 5. Calculate the payback period of running shoes. Year 1 234 4 2 3 Annual Net Cash Flow Future Net Cash Flows Year 1 $100,000 Year 2 $825,000 Year 3 $1,100,000 Year 4 $100,000 Salvage Value of Equipment $25,000 Cumulative Net Cash Flows 6. Calculate the NPV of running shoes. a) Notice that every year the company will receive a different cash flow. In order to calculate the PV of the total net cash flows, you will need to take the individual PV of each future cash flow and add them together.