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 8,000 13,000 15,000 17,000 1 2 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 Year 1-2 $46,000 $57,000 $47,000 4-6

Answer 1

Solution:

Calculation of Total Initial Investment

	$
Cost of Equipment	1,68,000.00
Increase in Working Capital	48,000.00
Total Initial Investment	2,16,000.00

Depreciation as per Straight Line Method = (Cost – Salvage value) / No of years

                                                                            = (168,000 – 12,000) / 6 = $26,000 per year

Solution 1) Calculation of Net Cash Inflows

	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Units Sold Sold	8,000	13,000	15,000	17,000	17,000	17,000
Sales $ (No. of units sold x $30)	2,40,000.00	3,90,000.00	4,50,000.00	5,10,000.00	5,10,000.00	5,10,000.00
Less: Variable Cost $ (No. of units Sold x $15)	1,20,000.00	1,95,000.00	2,25,000.00	2,55,000.00	2,55,000.00	2,55,000.00
Contribution $ = Sales - Variable Cost	1,20,000.00	1,95,000.00	2,25,000.00	2,55,000.00	2,55,000.00	2,55,000.00
Fixed Costs
Fixed Cost $ (Excluding Depreciation)	1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00	1,06,000.00
Yearly Advertising $	46,000.00	46,000.00	57,000.00	47,000.00	47,000.00	47,000.00
Total Fixed Costs $	1,52,000.00	1,52,000.00	1,63,000.00	1,53,000.00	1,53,000.00	1,53,000.00
Cash Inflows $	(32,000.00)	43,000.00	62,000.00	1,02,000.00	1,02,000.00	1,02,000.00
Add: Salvage Value of Machine $						12,000.00
Add: Recovery of Working Capital $						48,000.00
Net Cash Inflows $	(32,000.00)	43,000.00	62,000.00	1,02,000.00	1,02,000.00	1,62,000.00

Note: Depreciation will not be considered as it is a Non Cash Expenditure.

Solution 2a) Calculation of Net Present Value of the proposal

Year	Net Cash Inflows $	Present Value Factor @ 7%	Present Value of Net Cash Inflows $
1	-32,000.00	0.934579	-29,906.54
2	43,000.00	0.873439	37,557.87
3	62,000.00	0.816298	50,610.47
4	1,02,000.00	0.762895	77,815.31
5	1,02,000.00	0.712986	72,724.59
6	1,62,000.00	0.666342	1,07,947.44
		Total Present Value of Net Cash Inflows $	3,16,749.13

Net Present Value = Total Present Value of Net Cash Inflows $ - Initial Investment $

                                 = $316,749.13 - $216,000 = $100,749.13

Therefore, the Net Present Value of the proposal is $100,749.13.

Solution 2b) Yes, as the Net Present Value of the Proposal is positive, it is recommended that Matheson Electronics should accept the new product.