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.
