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: a.New equipment would have to be acquired to produce the device. The equipment would cost $294,000 and have a six-year useful life. After six years, it would have a salvage value of about $6,000. b.Sales in units over the next six years are projected to be as follows: Year Sales in Units 1 6,000 2 11,000 3 13,000 4–6 15,000 c.Production and sales of the device would require working capital of $45,000 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. d.The devices would sell for $50 each; variable costs for production, administration, and sales would be $30 per unit. e.Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $171,000 per year. (Depreciation is based on cost less salvage value.) f.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 $ 74,000 3 $ 54,000 4–6 $ 44,000 g.The company’s required rate of return is 8%. 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

All financials below are in $.

Annual depreciation = (Cost of new equipment - salvage value) / Life = (294,000 - 6,000) / 6 = 48,000

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $171,000 per year. (Depreciation is based on cost less salvage value.)

Hence, Fixed costs for salaries, maintenance, property taxes, insurance = 171,000 - 48,000 = 123,000

Part (1):

Please see the table below. Please see the column titled "Linkage". This will help you understand the mathematics behind every row. Final answers are in the last row, highlighted in yellow color cell.

Year, N	Linkage	1	2	3	4	5	6
Sale Price ($ / unit)	A	50	50	50	50	50	50
Variable costs for production, administration, and sales	B	30	30	30	30	30	30
Sales in Unit	C	16,000	11,000	13,000	15,000	15,000	15,000
Revenues	D = A x C	800,000	550,000	650,000	750,000	750,000	750,000
Variable costs for production, administration, and sales	E = B x C	480,000	330,000	390,000	450,000	450,000	450,000
Contribution Margin	F = D - E	320,000	220,000	260,000	300,000	300,000	300,000
Fixed Expenses
Fixed costs for salaries, maintenance, property taxes, insurance (Calculated prior to this table)	G (calculated before the table starts)	123,000	123,000	123,000	123,000	123,000	123,000
Advertising	H	74,000	74,000	54,000	44,000	44,000	44,000
Total Fixed Expenses	I = G + H	197,000	197,000	177,000	167,000	167,000	167,000
Net Cash Inflow/(Outflow)	J = F - I	123,000	23,000	83,000	133,000	133,000	133,000

Part (2) - a

Please see the table below for integrated cash flows:

Year, N	Linkage	0	1	2	3	4	5	6
Cost of equipment	A	-294,000
Working Capital	B	-45,000
Yearly Net Cash flows	J (from table in part (a)		123,000	23,000	83,000	133,000	133,000	133,000
Release working capital	C = -B							45,000
Salvage value -equipment	D							6,000
Total Cash flows	E = A+B+J+C+D	-339,000	123,000	23,000	83,000	133,000	133,000	184,000
Discount Factor (8%)	F = (1+8%)^(-N)	1.0000	0.9259	0.8573	0.7938	0.7350	0.6806	0.6302
Present Value	G = E x F	-339,000	113,889	19,719	65,888	97,759	90,518	115,951
Net Present Value	Sum of all G	164,724

Part (2) - b

Since, the NPV is positive, I would recommend that Matheson accept the device as a new product