Question

Case 13-32 Net Present Value Analysis of a New Product [LO13-2]

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 $300,000 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	10,000
2	15,000
3	17,000
4–6	19,000

1. Production and sales of the device would require working capital of $61,000 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 $30 each; variable costs for production, administration, and sales would be $10 per unit.
3. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $174,000 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	$	150,000
3	$	50,000
4–6	$	40,000

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

Solution 1:
Annual depreciation = (Cost - Salvage value) / Useful life = ($300,000 - $24,000) / 6 = $46,000
Computation of net cash inflow from sale of device
Particulars	Year 1	Year 2	Year 3	Year 4-6
Sales in units	10000	15000	17000	19000
Sales in dollar	$300,000.00	$450,000.00	$510,000.00	$570,000.00
Variable expenses	$100,000.00	$150,000.00	$170,000.00	$190,000.00
Contribution margin	$200,000.00	$300,000.00	$340,000.00	$380,000.00
Fixed Expenses:
Salaries and other (Excluding depreciation)	$128,000.00	$128,000.00	$128,000.00	$128,000.00
Advertising	$150,000.00	$150,000.00	$50,000.00	$40,000.00
Total fixed expenses	$278,000.00	$278,000.00	$178,000.00	$168,000.00
Net cash inflow (Outflow)	-$78,000.00	$22,000.00	$162,000.00	$212,000.00

Solution 2a:
Computation of Net Present Value - Matheson Electronics
Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cost of equipment	-$300,000
Working capital	-$61,000
Yearly net cash flows		-$78,000	$22,000	$162,000	$212,000	$212,000	$212,000
Release of working capital							$61,000
Salavage value of equipment							$24,000
Total cash flows	-$361,000	-$78,000	$22,000	$162,000	$212,000	$212,000	$297,000
PV Factor	1.000	0.885	0.783	0.693	0.613	0.543	0.480
Present Value	-$361,000	-$69,030	$17,226	$112,266	$129,956	$115,116	$142,560
Net present value	$87,094

Solution 2b: As NPV is positive, therefore Matheson should accept the device as a new product.