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 $150,000 and have a six-year useful life. After six years, it would have a salvage value of about $18,000.
2. Sales in units over the next six years are projected to be as follows:

Year	Sales in Units
1	7,000
2	12,000
3	14,000
4–6	16,000

3. Production and sales of the device would require working capital of $47,000 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 $151,000 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	$	45,000
3	$	56,000
4–6	$	46,000

7. The company’s required rate of return is 6%.

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			105000	180000	210000	240000
incremental fixed cost			174,000	174,000	185,000	175,000
Net cash inflow(outflow)			-69,000	6,000	25,000	65,000

2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-150,000
	Working capital			-47,000
	yearly net cash flows				-69,000	6,000	25,000	65,000	65,000	65,000
	Release of working capital									47,000
	Salvage value of Equipment									18,000
	total cash flows			-197,000	-69000	6000	25000	65000	65000	130000
	discount factor (6%)			1	0.943	0.89	0.84	0.792	0.747	0.705
	present value			-197,000	-65067	5340	21000	51480	48555	91650	-44,042
	Net present value			-44,042
2-b)	no

Working

Depreciation expense
(150000-18000)/6
22000
fixed costs for salaires (cash outflow)=
		151000-22000
		129000
			year 1	year 2	year 3	year 4-6
Sale in units			7,000	12,000	14,000	16,000
Sales in dollars			420000	720000	840000	960000
variable expenses			315000	540000	630000	720000
contribution margin			105000	180000	210000	240000
Fixed expenses:
Salaries and other			129,000	129,000	129,000	129,000
Advertising			45,000	45,000	56,000	46,000
total fixed expeneses			174,000	174,000	185,000	175,000
Net cash inflow(outflow)			-69,000	6,000	25,000	65,000