Question

CASE 7-32 Net Present Value Analysis of a New Product L07-2 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: a. 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 b. Sales in units over the next six years are projected to be as follows: Year Sales in Units 2.... 3.... 4-6.... 9,000 15,000 18,000 22,000 c. 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.

Answer 1

Particulars	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Sales in units	9,000	15,000	18,000	22,000	22,000	22,000
Sales	$315,000	$525,000	$630,000	$770,000	$770,000	$770,000
Variable costs	135,000	225,000	270,000	330,000	330,000	330,000
Fixed costs	135,000	135,000	135,000	135,000	135,000	135,000
Advertising	180,000	180,000	150,000	120,000	120,000	120,000
Profit before and after tax	(135,000)	(15,000)	75,000	185,000	185,000	185,000
Depreciation	50,000	50,000	50,000	50,000	50,000	50,000
Cash inflow	(85,000)	35,000	125,000	235,000	235,000	235,000
Present value factor @14%	0.87719	0.76947	0.67497	0.59208	0.51937	0.45559
Discounted cash inflow	(74,561)	26,931	84,371	139,139	122,052	107,063
Total discounted cash inflow - operation year wise						404,995
Total outflow at initiation of the project						(375,000)
Working capital received at disposition						27,335
Salvage value received at disposition						6,834
Net present value						64,164

a) The total net cash inflows without discounting over the six year period is $780,000.

b) The net present value of the proposed investment is $64,164. As the NPV is positive, Matheson should accept the device as a new product.

Note: As the tax rate has not been provided, its presumed that the tax rate is Nil.