The Scenario:

You work in the product development department of an athleticapparel company. Your company has decided to add a new product andis choosing between a polo tee, yoga pants, or running shoes.

You have been asked to evaluate the financial profitability ofeach option. You have estimated that the company has $1,500,000 toinvest in the project, and each product has the potential to bringin an estimated $2,000,000 of future cash flows, although thetiming of the cash flows varies per product.

Additionally, two of the products would use equipment that couldbe sold at the end of the project cycle. In order to pay for theproject, 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%	PV of an Annuity at 6%
1	0.94340	0.94340
2	0.89000	1.83339
3	0.83962	2.67301
4	0.79209	3.46511
5	0.74726	4.21236

Formulas:

	NPV = PV of total future net CF’s– initial cost

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 thePause and Reflect questions on page 5.

Option 1: Polo Shirts

Future Net Cash Flows
Year 1	$400,000
Year 2	$400,000
Year 3	$400,000
Year 4	$400,000
Year 5	$400,000

Today’s Cash Outflows
Initial investment	$1,500,000

1. Calculate the payback period of polo shirts.In other words, how many years will it take for the company torecoup the initial investment?

2. Calculate the NPV of polo shirts. In otherwords, when comparing apples to apples (the present value of cashinflows to the present value of cash outflows), what will theexpected profit of the project be?

Option 2: Yoga Pants

Future Net Cash Flows
Year 1	$500,000
Year 2	$500,000
Year 3	$500,000
Year 4	$500,000
Salvage Value of Equipment	$50,000

Today’s Cash Outflows
Initial investment	$1,500,000

3. Calculate the payback period of yoga pants.Because the equipment will be sold in the 4^th year,the cash flows for each year will not be the same (they are thesame for years 1-3, but not for year 4). Use the following setup tocalculate the payback period for a project with unequal cashflows:

Year	Annual Net Cash Flow	Cumulative Net Cash Flows
1
2
3
4

4. Calculate the NPV of polo shirts.

1. Notice that for all four years the company will receive thesame cash flow provided by the product. Use the PV of an annuitydiscount factor for this part of the calculation.

1. Notice also that the company will sell equipment in the4^th year for an additional cash flow. Which presentvalue table should you use when calculating a single sum? Add thisamount to the PV found in part a) to determine the PV of total netcash flows.

Option 3: Running Shoes

Future Net Cash Flows
Year 1	$300,000
Year 2	$600,000
Year 3	$750,000
Year 4	$350,000
Salvage Value of Equipment	$50,000

Today’s Cash Outflows
Initial investment	$1,500,000

5. Calculate the payback period of runningshoes.

Year	Annual Net Cash Flow	Cumulative Net Cash Flows
1
2
3
4

6. Calculate the NPV of running shoes.

1. Notice that every year the company will receive a differentcash flow. In order to calculate the PV of the total net cashflows, you will need to take the individual PV of each future cashflow and add them together.

Pause and Reflect:

1. Which product has the best NPV? Which has the best paybackperiod? Is there anything about these results that surprisesyou?

2. If given the opportunity to choose between a higher NPV or alower payback period, which would you choose and why?

3. Based on the information above, our company chooses to make_____________________

4. How did having a salvage value (such as with the yoga pants andrunning shoes) affect your payback and NPV calculations?

5. List two things that you learned from participating in thisactivity.