Question

Matheson Electronics has just developed a new electronic device that it believes will have broad market appeal. The company has performed marketing and cost studies that revealed the following information:

1. New equipment would have to be acquired to produce the device. The equipment would cost $180,000 and have a six-year useful life. After six years, it would have a salvage value of about $18,000.
2. Sales in units over the next six years are projected to be as follows:

Year	Sales in Units
1	9,000
2	14,000
3	16,000
4–6	18,000

3. Production and sales of the device would require working capital of $50,000 to finance accounts receivable, inventories, and day-to-day cash needs. This working capital would be released at the end of the project’s life.
4. The devices would sell for $40 each; variable costs for production, administration, and sales would be $25 per unit.
5. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $125,000 per year. (Depreciation is based on cost less salvage value.)
6. To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be:

Year	Amount of Yearly Advertising
1–2	$	48,000
3	$	59,000
4–6	$	49,000

7. The company’s required rate of return is 13%.

Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.

Required:

1. Compute the net cash inflow (incremental contribution margin minus incremental fixed expenses) anticipated from sale of the device for each year over the next six years.

2-a. Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment.

2-b. Would you recommend that Matheson accept the device as a new product?

Answer 1

			year 1	year 2	year 3	year 4-6
incremental contribution margin			135000	210000	240000	270000
incremental fixed cost			146,000	146,000	157,000	147,000
Net cash inflow(outflow)			-11,000	64,000	83,000	123,000

	(use factor tables as given in your question to get accurate answer)
2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-180,000
	Working capital			-50,000
	yearly net cash flows				-11,000	64,000	83,000	123,000	123,000	123,000
	Release of working capital									50,000
	Salvage value of Equipment									18,000
	total cash flows			-230,000	-11000	64000	83000	123000	123000	191000
	discount factor (13%)			1	0.885	0.783	0.693	0.613	0.543	0.48
	present value			-230,000	-9735	50112	57519	75399	66789	91680
	Net present value			101,764
2-b)	yes

Depreciation expense
(180000-18000)/6
27000
fixed costs for salaires (cash outflow)=
		125000-27000
		98000
			year 1	year 2	year 3	year 4-6
Sale in units			9,000	14,000	16,000	18,000
Sales in dollars			360000	560000	640000	720000
variable expenses			225000	350000	400000	450000
contribution margin			135000	210000	240000	270000
Fixed expenses:
Salaries and other			98,000	98,000	98,000	98,000
Advertising			48,000	48,000	59,000	49,000
total fixed expeneses			146,000	146,000	157,000	147,000
Net cash inflow(outflow)			-11,000	64,000	83,000	123,000