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 $264,000 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	13,000
2	18,000
3	20,000
4–6	22,000

Production and sales of the device would require working capital of $59,000 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 $50 each; variable costs for production, administration, and sales would be $35 per unit.

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $169,000 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	$	133,000
3	$	68,000
4–6	$	58,000

The company’s required rate of return is 16%.

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

Req 1:
Cash flows
			Year1	YEar2	YEar3	Year 4-6
Sales units			13000	18000	20000	22000
Selling price per unit			50	50	50	50
Less: Variable cost per unit			35	35	35	35
Contribution margin per unit			15	15	15	15
Contribution earned			195000	270000	300000	330000
Les: Fixed cost
Advertisement			133000	133000	68000	58000
Fixed cost Less dep			129000	129000	129000	129000
(169000 - 40000)
Annual cash flows			-67000	8000	103000	143000
Req 2:
			Year 0	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Initial investment			-264000
Working capital			-59000
Cash flowos				-67000	8000	103000	143000	143000	143000
Working capital released									59000
Salvage value									24000
Net cash flows			-323000	-67000	8000	103000	143000	143000	226000
PVf @ 16%			1	0.862069	0.743163	0.640658	0.552291	0.476113	0.410442
Present value of cashflows			-323000	-57758.6	5945.303	65987.74	78977.63	68084.16	92759.95
Net present value			-69004
Rreq 3:
No, it should not be accepted