Question

1. Cash Payback Method

   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.
   

   Payback period for liquid soap
   Payback period for body lotion

   b. The project with the_________ net cash flows in the early years of the project life will be favored over the one with the _________ net cash flows in the initial years.

Answer 1

Payback period for liquid soap

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	(540,000)	(540,000)
1	170,000	(370,000)
2	150,000	(220,000)
3	120,000	(100,000)
4	100,000	-
5	70,000	70,000
6	40,000	110,000
7	40,000	150,000
8	30,000	180,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 3.00 Years + ($100,000 / $100,000)

= 3.00 Years + 1.00 Year

= 4.00 Years

Payback period for body lotion

Year	Cash Flows ($)	Cumulative net Cash flow ($)
0	(540,000)	(540,000)
1	90,000	(450,000)
2	90,000	(360,000)
3	90,000	(270,000)
4	90,000	(180,000)
5	90,000	(90,000)
6	90,000	-
7	90,000	90,000
8	90,000	180,000

Payback Period = Years before full recover + (Unrecovered cash inflow at start of the year/cash flow during the year)

= 5.00 Years + ($90,000 / $90,000)

= 5.00 Years + 1.00 Year

= 6.00 Years

(b)-The project with the HIGHER net cash flows in the early years of the project life will be favored over the one with the LOWER net cash flows in the initial years.