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:

a. New equipment would have to be acquired to produce the device. The equipment would cost $1,182,000 and have a six-year useful life. After six years, it would have a salvage value of about $18,000.

b. Sales in units over the next six years are projected to be as follows:

Year Sales in Units

1 20,000

2 25,000

3 27,000

4–6 29,000

c. Production and sales of the device would require working capital of $64,000 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.

d. The devices would sell for $40 each; variable costs for production, administration, and sales would be $25 per unit.

e. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $156,000 per year. (Depreciation is based on cost less salvage value.)

f. 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	$	343,000
3	$	73,000
4–6	$	63,000

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

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.

*I need to know what the incremental fixed expenses for years 1, 2, 3, and 4-6 are.

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

Matheson	0	1	2	3	4	5	6
Unit Sales		20,000	25,000	27,000	29,000	29,000	29,000
Investment	-1,182,000
Salvage							18,000
NWC	-64,000						64,000
Sales		800000	1000000	1080000	1160000	1160000	1160000
VC		-500000	-625000	-675000	-725000	-725000	-725000
FC		-156000	-156000	-156000	-156000	-156000	-156000
Advertising		-343000	-343000	-73000	-63000	-63000	-63000
Profits		-199000	-124000	176000	216000	216000	216000
Cash Flows	-1,246,000	-5000	70000	370000	410000	410000	492,000
NPV	$45,449.77

Sales = Unit Sales x 40, Variable Cost (VC) = Unit Sales x 25

Depreciation = (Purchase - Salvage) / Life = (1,182,000 - 18,000) / 6 = 194,000

Cash Flows = Investment + NWC + Profits + Depreciation + Salvage

NPV can be calculated using discount factors or NPV function in excel or calculator with 7% discount rate.

NPV = $45,449.77. As NPV > 0, Matheson should accept the device.