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:

New equipment would have to be acquired to produce the device. The equipment would cost $486,000 and have a six-year useful life. After six years, it would have a salvage value of about $24,000.

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

Year	Sales in Units
1	18,000
2	23,000
3	25,000
4–6	27,000

Production and sales of the device would require working capital of $63,000 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.

The devices would sell for $35 each; variable costs for production, administration, and sales would be $20 per unit.

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $159,000 per year. (Depreciation is based on cost less salvage value.)

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	$	228,000
3	$	72,000
4–6	$	62,000

The company’s required rate of return is 18%.

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

	Depreciation expense
	(486000-24000)/6
	77000
	fixed costs for salaires (cash outflow)=
			159000-77000
			82000
				year 1	year 2	year 3	year 4-6
	Sale in units			18,000	23,000	25,000	27,000
	Sales in dollars			630000	805000	875000	945000
	variable expenses			360000	460000	500000	540000
	contribution margin			270000	345000	375000	405000
	Fixed expenses:
	Salaries and other			82,000	82,000	82,000	82,000
	Advertising			228,000	228,000	72,000	62,000
	total fixed expeneses			310,000	310,000	154,000	144,000
	Net cash inflow(outflow)			-40,000	35,000	221,000	261,000
2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-486,000
	Working capital			-63,000
	yearly net cash flows				-40,000	35,000	221,000	261,000	261,000	261,000
	Release of working capital									63,000
	Salvage value of Equipment									24,000
	total cash flows			-549,000	-40000	35000	221000	261000	261000	348000
	discount factor (18%)			1	0.847	0.718	0.609	0.516	0.437	0.37
	present value			-549,000	-33880	25130	134589	134676	114057	128760
	Net present value			-45,668
2-b)	No