Question

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 90,000Total $720,000 $720,000a. 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 1

Liquid soap

B. The liquid soap would be chosen because its pay back period is shorter than that of the body lotion.

even though both projects have the same total cash flows, the liquid soap project has greater cash flows in the ealier years compared to the other project. This makes the amount invested to be recovered more quickly and this makes it more desirable.

Step-by-step explanation:

Cash payback period measures how long it takes for the amount invested in a project to be recovered from the cumulative cash flow.

Cash payback for the liquid soap.

Amount invested = $-540,000

In the first year , the amount recovered = $- 540,000 + $170,000 = $-370,000

In the second year , the amount recovered = $-370,000 + 150,000 = $-220,000

In the third year , the amount recovered = $- 220,000 + 120,000 =$ -100,000

In the 4th year, the amount recovered = $ -100,000 + $100,000 =0

The total amount invested is recovered In the 4th year

Cash payback period for the body option =

Amount invested / net cash flows

$540,000 / $90,000 = 6 years

The amount invested is recovered In the 6th year

The liquid soap would be chosen because its pay back period is shorter than that of the body lotion.

even though both projects have the same total cash flows, the liquid soap project has greater cash flows in the ealier years compared to the other project. This makes the amount invested to be recovered more quickly and this makes it more desirable.

I hope my answer helps you