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 $246,000 and have a six-year useful life. After six years, it would have a salvage value of about $24,000.
2. Sales in units over the next six years are projected to be as follows:

Year	Sales in Units
1	14,000
2	19,000
3	21,000
4–6	23,000

1. Production and sales of the device would require working capital of $57,000 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 $132,000 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	$	133,000
3	$	66,000
4–6	$	56,000

1. The company’s required rate of return is 15%.

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

1
A.	Initial Investments
	Particulars	Amount ($)
	Cost of Equipment	(2,46,000)
	Working Capital	(57,000)
	Total Investment	(3,03,000)
B.	Computaion of Yearly Net Cash inflow
								Amount ($)
	Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6	Total
	Sales Units	14,000	19,000	21,000	23,000	23,000	23,000	1,23,000
	Sales @ $40	5,60,000	7,60,000	8,40,000	9,20,000	9,20,000	9,20,000	49,20,000
	Less:- Variable Cost @ $25	3,50,000	4,75,000	5,25,000	5,75,000	5,75,000	5,75,000	30,75,000
	Incremental Contribution Margin	2,10,000	2,85,000	3,15,000	3,45,000	3,45,000	3,45,000	18,45,000
	Less:- Incremental Fixed Cost	1,32,000	1,32,000	1,32,000	1,32,000	1,32,000	1,32,000	7,92,000
	Less:- Incremental Advertising Cost	1,33,000	1,33,000	66,000	56,000	56,000	56,000	5,00,000
	EBIT	(55,000)	20,000	1,17,000	1,57,000	1,57,000	1,57,000	5,53,000
	Add:- Depreciation	37,000	37,000	37,000	37,000	37,000	37,000	2,22,000
	Net Cash Inflow/(Outflow)	(18,000)	57,000	1,54,000	1,94,000	1,94,000	1,94,000	7,75,000
	PVF@15%	0.870	0.756	0.658	0.572	0.497	0.432
	Present Value of Net Cash Inflow/(Outflow)	(15,660)	43,092	1,01,332	1,10,968	96,418	83,808	4,19,958
C	Residual Cash Flows
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