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 $474,000 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 $62,000 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 $30 each; variable costs for production, administration, and sales would be $15 per unit.

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $144,000 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	$	223,000
3	$	71,000
4–6	$	61,000

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

Rreq 1
			Year1	Year2	YEar3	Year 4-6
Sales units			18000	23000	25000	27000
Selling price per unit			30	30	30	30
Lless: Variable cost per unit			15	15	15	15
Contribution margin			15	15	15	15
Total Contribution margin			270000	345000	375000	405000
Less: Fixed cost less dep			69000	69000	69000	69000
Less: Advertisement			223000	223000	71000	61000
Net Cash inflows			-22000	53000	235000	275000
Req 2:
			Year0	YEar1	Year2	Year3	Year4	Yaear5	Year6
Initial investmemnt			-474000
Working capital			-62000
Annual inflows				-22000	53000	235000	275000	275000	275000
Salvage realised									24000
Working capital realised									62000
Net Cash flows			-536000	-22000	53000	235000	275000	275000	361000
PVF @18%			1	0.847458	0.718184	0.608631	0.515789	0.437109	0.370432
Present value of cash flows			-536000	-18644.1	38063.77	143028.3	141841.9	120205	133725.8
Net present value			22220
Req 3:
Yes, proposal must be accepted