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:

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.

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

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.

The devices would sell for $45 each; variable costs for production, administration, and sales would be $25 per unit.

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.)

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

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

Click here to view Exhibit 13B-1 and Exhibit 13B-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.)

Answer 1

	selling price per unit	45	variable cost	25
	year	0	1	2	3	4	5	6
	sales in units		6000	11000	13000	15000	15000	15000
	sales in dollars = units*selling price		270000	495000	585000	675000	675000	675000
	less variable cost in dollars = units sold*variable cost per unit		150000	275000	325000	375000	375000	375000
	contribution margin		120000	220000	260000	300000	300000	300000
	lessfixed cost for salaries and others except depreciation) = 132000-17000		115000	115000	115000	115000	115000	115000
	less advertising expense		74000	74000	53000	43000	43000	43000
	total operating expenses		189000	189000	168000	158000	158000	158000
1-	net cash inflow		-69000	31000	92000	142000	142000	142000
	Annual depreciation	cost of machine-scrap value / life of machine	(120000-18000)/6	17000
2-	cash outflow
	cost of machine		-120000
	additional working capital		-44000
	total cash outflow		-164000
	cash inflow in year 6	net cash inflow + recovery of working capital+scrap value of machine	142000+44000+18000	204000
	Year	net cash flow	present value factor at 15% = 1/(1+r)^n r =15%	present value of cash flow = net cash flow*present value factor
	0	-164000	1	-164000
	1	-69000	0.869565	-60000
	2	31000	0.756144	23440.45
	3	92000	0.657516	60491.49
	4	142000	0.571753	81188.96
	5	142000	0.497177	70599.1
	6	204000	0.432328	88194.83
	Net present value	sum of present value of net cash flow		99914.83
	Yes he should accept the device as NPV is positive