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

1. 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.
2. The devices would sell for $40 each; variable costs for production, administration, and sales would be $25 per unit.
3. 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.)
4. 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

1. 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

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ANSWER:

Required 1)

Annual depreciation = (180,000 - 18,000) / 6 = 27,000

Computation of net cash inflow from sale of device

Particulars	Year 1	Year 2	Year 3	Year 4-6
Sales in units (A)	9,000	14,000	16,000	18,000
Sales in dollar (B = A * 40)	$360,000	$560,000	$640,000	$720,000
Variable expenses (C = A * 25)	$225,000	$350,000	$400,000	$450,000
Contribution margin (D = B - C)	$135,000	$210,000	$240,000	$270,000
Fixed Expenses
Salaries and other (Excluding depreciation) (125,000 - 27,000)	$98,000	$98,000	$98,000	$98,000
Advertising	$48,000	$48,000	$59,000	$49,000
Total fixed expenses (E)	$146,000	$146,000	$157,000	$147,000
Net cash inflow (Outflow) (F = D - E)	($11,000)	$64,000	$83,000	$123,000

Required 2 a)

Computation of Net Present Value - Matheson Electronics

Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5	Year 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
Salavage value of equipment							$18,000
Total cash flows	($230,000)	($11,000)	$64,000	$83,000	$123,000	$123,000	191,000
PV Factor	1.000	0.943	0.890	0.840	0.792	0.747	0.705
Present Value	($230,000)	($10,373‬)	$56,960‬	$69,720	$97,416	$91,881‬	$134,655
Net present value	$210,259‬

Required 2 b)

As NPV is positive, therefore Matheson should accept the device as a new product.