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 $198,000 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	10,000
2	15,000
3	17,000
4–6	19,000

Production and sales of the device would require working capital of $52,000 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 $140,000 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	$	55,000
3	$	61,000
4–6	$	51,000

The company’s required rate of return is 12%.

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
	(198000-24000)/6
	29000
	fixed costs for salaires (cash outflow)=
			140,000-29000
			111000
1)				year 1	year 2	year 3	year 4-6
	Sale in units			10,000	15,000	17,000	19,000
	Sales in dollars			500000	750000	850000	950000
	variable expenses			350000	525000	595000	665000
	contribution margin			150000	225000	255000	285000
	Fixed expenses:
	Salaries and other			111,000	111,000	111,000	111,000
	Advertising			55,000	55,000	61,000	51,000
	total fixed expeneses			166,000	166,000	172,000	162,000
	Net cash inflow(outflow)			-16,000	59,000	83,000	123,000
2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-198,000
	Working capital			-52,000
	yearly net cash flows				-16,000	59,000	83,000	123,000	123,000	123,000
	Release of working capital									52,000
	Salvage value of Equipment									24,000
	total cash flows			-250,000	-16000	59000	83000	123000	123000	199000
	discount factor (12%)			1	0.893	0.797	0.712	0.636	0.567	0.507
	present value			-250,000	-14288	47023	59096	78228	69741	100893
	Net present value			90,693
2-b)	yes