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 $168,000 and have a six-year useful life. After six years, it would have a salvage value of about $12,000. b. Sales in units over the next six years are projected to be as follows: Sales in Units Year 1 8,000 13,000 2 3 15,000 17,000 4-6 c. Production and sales of the device would require working capital of $48,000 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 $30 each; variable costs for production, administration, and sales would be $15 per unit e. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $132,000 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: Amount of Yearly Advertising $46,000 $57,000 $47,000 ear 1-2 3 4-6

Answer 1

Incremental Contribution Margin = Sales – Variable Cost

Incremental Contribution Margin is Point No 4 in Below Table

Incremental Fixed Expenses are expenses which are associated with incremental productions. Usually Rents, Depreciation, Salary and taxes are not incremental as they are fix in nature. Here Advertising expenses are incremental in nature and associate to boost the sale of product.

Incremental Fixed Expenses is Advertising Expenses point on 6 in below table

		0	1	2	3	4	5	6
1	Sales in Units		8000	13000	15000	17000	17000	17000
2	Revenue @30 Rupees Sales Price		240000	390000	450000	510000	510000	510000
3	Variable Cost @ 15 Rupees		120000	195000	225000	255000	255000	255000
4	Incremental Contribution Margin (2-3)		120000	195000	225000	255000	255000	255000
5	Advertising Cost		46000	46000	57000	47000	47000	47000
6	Incremental Fixed Expenses		46000	46000	57000	47000	47000	47000

Depreciation Per Year = (Cost - Resale Value)/ No of Years, through it's included in Fixed Cost but need to calculate this to get the cash flow. = (168000-12000)/6 = 26000

As tax rate in not given so assuming zero tax to calculate NPV Cost of Capital =7%

Net Cash Flows are given in below table, point no 12 in table

		0	1	2	3	4	5	6
1	Sales in Units		8000	13000	15000	17000	17000	17000
2	Revenue @30 Rupees Sales Price		240000	390000	450000	510000	510000	510000
3	Fixed Cost		132000	132000	132000	132000	132000	132000
4	Variable Cost @ 15 Rupees		120000	195000	225000	255000	255000	255000
5	Advertising Cost		46000	46000	57000	47000	47000	47000
6	Profit (Revenue - Fixed Cost - Variable Cost - Advertising Cost)		-58000	17000	36000	76000	76000	76000
7	Depreciation (Part of Fixed Assets)		26000	26000	26000	26000	26000	26000
8	Adding Back Depreciation to get Cash Flow		-32000	43000	62000	102000	102000	102000
9	Cost	-168000
10	Working Capital Requirement	-48000						48000
11	Resale Value							12000
12	Total Cash Flow	-216000	-32000	43000	62000	102000	102000	162000
13	Cost of Capital 7%
14	Discounting Cash Flow using Cost of Capital	-216000	-29907	37558	50610	77815	72725	107947
15	Total Present Value of Cash Inflows	316749
16	Net Present Value = Total of Cash Inflows - Total of Cash Outflows at 0)	100749

NPV is point no 16 in above table. which is 100,749