Using the Payback Method and NPV

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 $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:

Option 2: Yoga Pants

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
1
2
3
4

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.