Question

Use your discussion group to complete this assignment. Discuss with your group the following case using this discussion board. Once you have come to a group resolution clearly label that final post as "final answers".

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

Solution 1:

Annual depreciation = (Cost - Salvage value) / useful life = ($315,000 - $15,000) / 6 = $50,000

Computation of net cash inflow from sale of device
Particulars	Year 1	Year 2	Year 3	Year 4-6
Sales in units	9000	15000	18000	22000
Sales in dollar	$315,000.00	$525,000.00	$630,000.00	$770,000.00
Variable expenses	$135,000.00	$225,000.00	$270,000.00	$330,000.00
Contribution margin	$180,000.00	$300,000.00	$360,000.00	$440,000.00
Fixed Expenses:
Salaries and other (Excluding depreciation)	$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
Total fixed expenses	$265,000.00	$265,000.00	$235,000.00	$205,000.00
Net cash inflow (Outflow)	-$85,000.00	$35,000.00	$125,000.00	$235,000.00

Solution 2:

Computation of Net Present Value - Matheson Electronics
Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cost of equipment	-$315,000
Working capital	-$60,000
Yearly net cash flows		-$85,000	$35,000	$125,000	$235,000	$235,000	$235,000
Release of working capital							$60,000
Salavage value of equipment							$15,000
Total cash flows	-$375,000	-$85,000	$35,000	$125,000	$235,000	$235,000	$310,000
PV Factor	1.000	0.877	0.769	0.675	0.592	0.519	0.456
Present Value	-$375,000	-$74,545	$26,915	$84,375	$139,120	$121,965	$141,360
Net present value	$64,190

As NPV is positive, therefore Matheson should accept the device as a new product