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:

1. New equipment would have to be acquired to produce the device. The equipment would cost $480,000 and have a six-year useful life. After six years, it would have a salvage value of about $12,000.
2. Sales in units over the next six years are projected to be as follows:

Year	Sales in Units
1	15,000
2	20,000
3	22,000
4–6	24,000

3. Production and sales of the device would require working capital of $61,000 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 $60 each; variable costs for production, administration, and sales would be $45 per unit.
5. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $155,000 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	$	218,000
3	$	70,000
4–6	$	60,000

7. The company’s required rate of return is 15%.

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

1	Statement of net cash inflow each year
		year 1 ($)	year 2 ($)	year 3 ($)	year 4-6 ($)
	Sales in unit	15000	20000	22000	24000
	Sales in dollars (A)	900000	1200000	1320000	1440000
	Variable expense (B)	675000	900000	990000	1080000
	Contribution margin (A-B)=C	225000	300000	330000	360000
	Fixed Expense
	salaries and others (D)	77000	77000	77000	77000
	Advertising €	218000	218000	70000	60000
	Total fixed expense (D+E)=F	295000	295000	147000	137000
	Net cash Inflow (C-F)	-70000	5000	183000	223000
	Note:
	salaries and others (A)	155000	155000	155000	155000
	Depreciation (B) (480000-12000)/6	78000	78000	78000	78000
	(A-B)	77000	77000	77000	77000
2 (a)	Statement of net present value
		year 0 ($)	year 1 ($)	year 2 ($)	year 3 ($)	year 4 ($)	year 5 ($)	Year 6 ($)
	Cost of equipment	-480000
	Working capital	-61000
	Yearly net cash flows		-70000	5000	183000	223000	223000	223000
	Release working capital							61000
	salvage value							12000
	Total cash flows	-541000	-70000	5000	183000	223000	223000	296000
	Discount factor	1	0.8696	0.7561	0.6575	0.5718	0.4972	0.4323
	Present value	-541000	-60869.57	3780.72	120325.47	127500.97	110870.41	127968.97
	Net present value	-111423.0
2(b)	No, because NPV of the device is negative