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 $240,000 and have a six-year useful life. After six years, it would have a salvage value of about $18,000.

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 $56,000 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 $151,000 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	$	128,000
3	$	65,000
4–6	$	55,000

The company’s required rate of return is 17%.

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

			year 1	year 2	year 3	year 4-6
incremental contribution margin			195000	270000	300000	330000
incremental fixed cost			242,000	242,000	179,000	169,000
Net cash inflow(outflow)			-47,000	28,000	121,000	161,000

2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-240,000
	Working capital			-56,000
	yearly net cash flows				-47,000	28,000	121,000	161,000	161,000	161,000
	Release of working capital									56,000
	Salvage value of Equipment									18,000
	total cash flows			-296,000	-47000	28000	121000	161000	161000	235000
	discount factor (17%)			1	0.855	0.731	0.624	0.534	0.456	0.39
	present value			-296,000	-40185	20468	75504	85974	73416	91650	10,827
	Net present value			10,827
2-b)	yes

Depreciation expense
(240000-18000)/6
37000
fixed costs for salaires (cash outflow)=
		151000-37000
		114000
			year 1	year 2	year 3	year 4-6
Sale in units			13,000	18,000	20,000	22,000
Sales in dollars			455000	630000	700000	770000
variable expenses			260000	360000	400000	440000
contribution margin			195000	270000	300000	330000
Fixed expenses:
Salaries and other			114,000	114,000	114,000	114,000
Advertising			128,000	128,000	65,000	55,000
total fixed expeneses			242,000	242,000	179,000	169,000
Net cash inflow(outflow)			-47,000	28,000	121,000	161,000