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 $2,000,000 to invest in the project, and each product has the potential to bring in an estimated $3,000,000 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 PV of 1 at 6% 0.94340 0.89000 0.83962 0.79209 .74726 PV of an Annuity at 6% 0.94340 1.83339 2.67301 3.46511 4.21236 5 0 Formulas: NPV = PV of total future net CF's - initial cost Payback period = cost of investment (for same CF's) annual net 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 at the end. Option 1: Polo Shirts Today's Cash Outflows Initial investment $2,000,000 Future Net Cash Flows Year 1 $600.000 Year 2 $600,000 Year 3 $600,000 Year 4 $600,000 Year 5 $600,000 1. Calculate the payback period of polo shirts. In other words, how many years will it take for the company to recoup the initial investment? 2. Calculate the NPV of polo shirts. In other words, when comparing apples to apples (the present value of cash inflows to the present value of cash outflows), what will the expected profit of the project be? Option 2: Yoga Pants Today's Cash Outflows Initial investment $2.000.000 | Future Net Cash Flows Year 1 $750,000 Year 2 $750,000 Year 3 $750,000 Year 4 $750,000 Salvage Value $50,000 of Equipment 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 Annual Net Cash Flow Cumulative Net Cash Flows Finish payback calculation here: 4. Calculate the NPV of yoga pants. a) The company will receive the same cash flows provided by the product for years 1-3. Use the PV of an annuity discount factor for this part of the calculation. b) In the 4th year there is an additional cash flow (the money brought in by the sale of the equipment). Which present value table should you use when calculating a single sum? Use the sum of both cash flows to find the PV for year 4. Option 3: Running Shoes Today's Cash Outflows Initial investment $2,000,000 Future Net Cash Flows Year 1 $700,000 | Year 2 $800,000 Year 3 $800,000 Year 4 $700,000 Salvage Value $50,000 of Equipment 5. Calculate the payback period of running shoes. Year Annual Net Cash Flow Cumulative Net Cash Flows Finish payback calculation here: 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. Like the yoga pants, the total year 4 cash flows will be a sum of two values