Sami is considering adding toys to her general store. She hired a SMU student, Aaron, to do an analysis of the project and paid him $500 last month. Aaron estimated that the initial investment for this new toy line will be $85,000. Toy sales are expected to produce after tax cash flows of $15,000 per year over the next ten years. Sami has determined her cost of capital is 7%.

a) Based on the payback method, should Sami add toys to her store if she requires a three-year payback period for all projects? Why or why not? Show your work. (4 Marks)

b) Based on NPV analysis, should Sami add toys to her general store? Show your work. (4 Marks)

c) Shelf space in the general store is quite limited and Sami is considering adding a line of pet supplies instead of toys. She has asked Aaron to make a recommendation on which product line she should choose. Aaron remembers from his Finance class that the goal is to maximize the value of the company.

Aaron has determined the following:

IRR of the toy product line: 11.93%

NPV of the pet supply product line: $10,000

IRR of the pet supply product line: 12.5%

Which product line should Aaron recommend? Explain. (2 Marks)