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 7B-1 and Exhibit 7B-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?

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. (Negative amounts should be indicated by a minus sign.)

	Year 1 Year 2 Year 3 Year 4-6 Incremental contribution margin Incrememental fixed expenses $174,000 $174,000 $185,000 $175,000 Net cash inflow (outflow)

Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. (Negative amounts should be indicated by a minus sign. Round your final answer to the nearest whole dollar amount.)

	Net present value

Answer 1

			year 1	year 2	year 3	year 4-6
incremental contribution margin			105000	180000	210000	240000
incremental fixed cost			170,000	170,000	181,000	171,000
Net cash inflow(outflow)			-65,000	10,000	29,000	69,000

2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-150,000
	Working capital			-47,000
	yearly net cash flows				-65,000	10,000	29,000	69,000	69,000	69,000
	Release of working capital									47,000
	Salvage value of Equipment									18,000
	total cash flows			-197,000	-65000	10000	29000	69000	69000	134000
	discount factor (6%)			1	0.943	0.89	0.84	0.792	0.747	0.705
	present value			-197,000	-61295	8900	24360	54648	51543	94470
	Net present value			-24,374
2-b)	yes

working notes

Depreciation expense
(150000-18000)/6
26000
fixed costs for salaires (cash outflow)=
		151000-26000
		125000
			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			125,000	125,000	125,000	125,000
Advertising			45,000	45,000	56,000	46,000
total fixed expeneses			170,000	170,000	181,000	171,000
Net cash inflow(outflow)			-65,000	10,000	29,000	69,000