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.

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

1. New equipment would have to be acquired to produce the device. The equipment would cost $315,000 and have a six year useful life. After six years, it would have a salvage value of about $15, 000.
2. Sales in units over the next six years is projected to be as follows:

Year	Sales in Units
1	9,000
2	15,000
3	18,000
4-6	22,000

1. Production and sales of the device would require a working capital of $60, 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 $35 each; variable cost for production, administration, and sales would be $15 per unit.
3. Fixed cost for salaries, maintenance, property taxes, insurance, and straight line depreciation on the equipment would be total $135, 000 (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 program would be

Year	Amount of Yearly Advertising
1-2	$180, 000
3	$150, 000
4-6	$120, 000

1. The company’s required rate of return is 14%

Required

1. Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the device for each year over the next six years

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Sales in Unit	9,000	15,000	18,000	22,000	22,000	22,000
Selling Price Per Unit	35	35	35	35	35	35
Net Sales	$315,000	$525,000	$630,000	$770,000	$770,000	$770,000
Less: Variable Cost ($15 per unit)	$135,000	$225,000	$270,000	$330,000	$330,000	$330,000
Contribution Margin	$180,000	$300,000	$360,000	$440,000	$440,000	$440,000
Less: Fixed Cost	$135,000	$135,000	$135,000	$135,000	$135,000	$135,000
Less: Advertising Expenses	$180,000	$180,000	$150,000	$120,000	$120,000	$120,000
Net Income	$(135,000)	$(15,000)	$75,000	$185,000	$185,000	$185,000
Add: Depreciation	$50,000	$50,000	$50,000	$50,000	$50,000	$50,000
Cash Inflows	$(85,000)	$35,000	$125,000	$235,000	$235,000	$235,000

Depreciation:

Cost of Equipment	$ 315,000
Less Salvage Value	15,000
Net Depreciable Cost	$300,000

$300,000/ 6 years = $50,000 per year depreciation

1. Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. Would you recommend the Matheson accept the device as a new product?

Item	Year	Amount of Cash	14% Factor	Present Value of Cash Flows
Investment in Equipment	Now	$(315,000)	1	$(315,000)
Working Capital Investment	Now	$(60,000)	1	$(60,000)
Yearly Cash Flows	1	$(85,000)	0.877	$(74,545)
	2	$35,000	0.769	$26,915
	3	$125,000	0.675	$84,375
	4	$235,000	0.592	$139,120
	5	$235,000	0.519	$121,965
	6	$235,000	0.456	$107,160
Salvage Value of Equipment	6	$15,000	0.456	$6,840
Release of working Capital	6	$60,000	0.456	$27,360
Net Present Value				$64,190

Since the Net Present Value is Positive, then Matheson should accept the device as a new product.