Lily Products Company is considering an investment in one of two new product lines. The investment required for either product line is $540,000

Lily Products Company is considering an investment in one of two new product lines. The investment required for either product line is $540,000. The net cash flows associated with each product are as follows:

Year | Liquid Soap | Body Lotion
1    |  $170,000   |  $ 90,000
2    |   150,000   |    90,000
3    |   120,000   |    90,000
4    |   100,000   |    90,000
5    |    70,000   |    90,000
6    |    40,000   |    90,000
7    |    40,000   |    90,000
8    |    30,000   |    90,000
Total|  $720,000   |  $720,000

a. Recommend a product offering to Lily Products Company, based on the cash payback period for each product line.

b. Why is one product line preferred over the other, even though they both have the same total net cash flows through eight periods?


Answer:

a. The Liquid Soap product line is recommended, based on its shorter cash 
payback period. The cash payback period for both products can be determined 
using the following schedule: 
Initial investment:  $540,000 
Liquid Soap 

Body Lotion 


Net Cash 
Flow 
 Cumulative 
Net Cash 
Flows 


Net Cash 
Flow 
 Cumulative 
Year 1……………………………… $170,000  $170,000  $90,000  $  90,000 
Year 2……………………………… 150,000  320,000  90,000  180,000 
Year 3……………………………… 120,000  440,000  90,000  270,000 
Year 4……………………………… 100,000  540,000  90,000  360,000 
Year 5………………………………     90,000  450,000 
Year 6………………………………     90,000  540,000 
Liquid Soap has a four-year cash payback period, and Body Lotion has a six- 
year cash payback. 
b. The cash payback periods are different between the two product lines because 
Liquid Soap earns cash faster than does Body Lotion. Even though both 
products earn the same total net cash flow over the eight-year planning horizon, 
Liquid Soap returns cash faster in the earlier years. The cash payback method 
emphasizes the initial years’ net cash flows in determining the cash payback 
period. Thus, the project with the greatest net cash flows in the early years of 
the project life will be favored over the one with less net cash flows in the initial 
years.