Question

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

Answer-a)-Cash payback period- Liquid Soap = 4 years.

Explanation- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

When cash inflows are uneven, then calculate cumulative net cash flow for each period and

Then use the following formula for payback period:

Payback period =A+B/C Where:-A is the last period with a negative cumulative cash flow; B is the absolute value of cumulative cash flow at the end of the period A; C is the total cash flow during the period after A Liquid Soap = 3 years + ($100000/$100000) = 4 years Cash payback period- Body Lotion = 6 years.

Explanation- Payback period is the time in which the initial cash outflow of an investment is expected to be recovered from the cash inflows generated by the investment. It is one of the simplest investment appraisal techniques.

In case when cash inflow are even, the formula to calculate payback period is:

Payback period =Initial investment / Cash Inflow per period

= $540000/$90000

= 6 years

Based on the cash payback period for each product line, Lily Products Company should accept liquid soap product.

b)- The project with the Liquid Soap  net cash flows in the early years of the project life will be favored over the one with the Body Lotion net cash flows in the initial years.