Question

Matheson Electronics has just developed a new electronic device 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 $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 are projected to be as follows:

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

3. Production and sales of the device would require 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.

4. The devices would sell for $35 each; variable costs for production, administration, and sales would be $15 per unit.

5. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $135,000 per year. (Depreciation is based on cost less salvage value.)

6. 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		$180,000
   3		$150,000
   4–6		$120,000

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

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. 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 that Matheson accept the device as a new product?

Answer 1

Part-1 Statement showing Computation of Net cash flow-Matheson Electronics- Electronic devices
	Year 1	Year 2	Year 3	Year 4	Year-5	Year 4-6
Unit (a)	9000	15000	18000	22000	22000	22000
Sales (aX $35)	$315,000.00	$525,000.00	$630,000.00	$770,000.00	$770,000.00	$770,000.00
Less: Variable Expenses (aX15)	$135,000.00	$225,000.00	$270,000.00	$330,000.00	$330,000.00	$330,000.00
Contribution Margin (b)	$180,000.00	$300,000.00	$360,000.00	$440,000.00	$440,000.00	$440,000.00
Fixed Expenses:
Salaries And Other (other than Depreciation) (135000-50000)	$85,000.00	$85,000.00	$85,000.00	$85,000.00	$85,000.00	$85,000.00
Advertising	$180,000.00	$180,000.00	$150,000.00	$120,000.00	$120,000.00	$120,000.00
Total Fixed Expenses (C )	$265,000.00	$265,000.00	$235,000.00	$205,000.00	$205,000.00	$205,000.00
Net Cash Inflow /(Outflow) (b-c)	($85,000.00)	$35,000.00	$125,000.00	$235,000.00	$235,000.00	$235,000.00
* Depreciation = (315000-15000)/6=50000

Part-2 Statement showing Computation of Net Present value-Matheson Electronics- Electronic devices
Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cost Of Equipment	($315,000)
Working Capital	($60,000)
Annual Net Cash Inflow/(Outflow)		($85,000)	$35,000	$125,000	$235,000	$235,000	$235,000
Release Of Working Capital At End							$60,000
Salvage Value Of Equipment							$15,000
Annual Cash Flows (a)	($375,000)	($85,000)	$35,000	$125,000	$235,000	$235,000	$310,000
PVF @ 14% (b)	1	0.877	0.769	0.675	0.592	0.519	0.456
Present Value (aXb)	($375,000)	($74,545)	$26,915	$84,375	$139,120	$121,965	$141,360
Net Present Value	$64,190

yes, Matheson should accept the device as a new product beccasue NPV is positive.