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 $120,000 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	6,000
2	11,000
3	13,000
4–6	15,000

3. Production and sales of the device would require working capital of $44,000 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 $45 each; variable costs for production, administration, and sales would be $25 per unit.
5. 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.)
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	$	74,000
3	$	53,000
4–6	$	43,000

7. The company’s required rate of return is 15%.

Click here to view Exhibit 12B-1 and Exhibit 12B-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

Answer with working notes is given below

Year 1 6,000 Year 5 15,000 Year 6 15,000 $45 $45 $45 $25 $25 $20 Sales units Selling price Variable cost Contribution per unit Incremental Contribution Margin Less: Fixed Cost Advertising Net Income Add: Depreciation (Non cash item) Net annual cash inflow/(outflow) $20 $120,000 $132,000 $74,000 $86,000 $17,000 $69,000 Year 2 11,000 $45 $25 $20 $220,000 $132,000 $74,000 $14,000 $17,000 $31,000 Year 3 13,000 $45 $25 $20 $260,000 $132,000 $53,000 $75,000 $17,000 $92,000 Year 4 15,000 $45 $25 $20 $300,000 $132,000 $43,000 $125,000 $17,000 $142,000 $25 $20 $300,000 $132,000 $43,000 $125,000 $300,000 $132,000 $43,000 $125,000 $142,000 $142,000 Depreciation per year Cost of machine Salvage value Net cost Depreciation per year $120,000 $18,000 $102,000 $17,000 ($102,000/6 years) Initial investment Cost of Machine Working capital Total Investment $120,000 $44,000 $164,000 Year 0 -$164,000 Year 1 $69,000 Year 2 $31,000 Year 3 $92,000 Year 4 $142,000 Year 5 $142,000 Net annual cash (Outflow) inflow Salvage value Working capital released Total Annual cash (Outflow) inflow Present value factor at 15% Present value of Cash flows Year 6 $142,000 $18,000 $44,000 $204,000 0.4323 $88,195 -$164,000 1.0000 $164,000 $69,000 0.8696 $60,000 $31,000 0.7561 $23,440 $92,000 0.6575 $60,491 $142,000 0.5718 $81,189 $142,000 0.4972 $70,599 | Net present value $99,915 2 b) Accept the device as a new product since NPV is positive