Question

Matheson Electronics has just developed a new electronic device 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 $315,000 and have a six-year useful life. After six years, it would have a salvage value of about $15,000. 2. Sales in units over the next six years are projected to be as follows: Year Sales in Units 9,000 15,000 18,000 22,000 4-6 3. Production and sales of the device would require working capital of $60,000 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. Page 393 The devices would sell for $35 each; variable costs for production, administration, and sales would be $15 per unit. 5. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $135,000 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 $180,000 3 $150,000 4-6 $120,000 7. The company's required rate of return is 14%. Required:

Answer 1

0 2 T 4 5 6 1. Computation of Net Cash Flow from sale of device over the next 6 Years. Particulars 3 Initial Investment : New Equipment $ -3,15,000 Working Capital $ -60,000 Annual Cash Flow : Revenue : Units Sale Price per Unit Sales Revenue 9,000 35 3,15,000 15,000 $ 35 $5,25,000 $ 35 $ 6,30,000 22,000 $ 35 $ 7,70,000 22,000 $ 35 $ 7,70,000 22,000 $ $ 7,70,000 35 $ Variable Costs : Units Cost per Unit Variable Costs $ $ 9,000 15 1,35,000 15,000 $ 15 $2,25,000 18,000 $ 15 $ 2,70,000 22,000 $ 15 $ 3,30,000 22,000 $ 15 $ 3,30,000 22,000 $ 15 $ 3,30,000 Contribution $ 1,80,000 $3,00,000 $ 3,60,000 $ 4,40,000 $ 4,40,000 $ 4,40,000 Fixed Costs : Property Taxes, Insurance and Depreciation $ 1,35,000 $1,35,000 $ 1,35,000 $ 1,35,000 $ 1,35,000 $ 1,35,000 Advertisement Costs Total Fixed Costs $ $ 1,80,000 3,15,000 $1,80,000 $3,15,000 $ 1,50,000 $ 2,85,000 $ 1,20,000 $ 2,55,000 $ 1,20,000 $ 2,55,000 $ 1,20,000 $ 2,55,000 Net Income Add : Depreciation Annual Cash Inflow $-1,35,000 $-15,000 $ 75,000 $1,85,000 $ 50,000 $ 50,000 $ 50,000 $ 50,000 $ -85,000 $ 35,000 $1,25,000 $2,35,000 $1,85,000 $ 50,000 $2,35,000 $1,85,000 $ 50,000 $2,35,000 End of Project Cash Flow : Salvage Value Release of Working Capital $ $ 15,000 60,000

5 6 $ 2,35,000 2. Using the data calculated above in (1), Computation of Net Present Value: Particulars O 2 4 Initial Investment $ -3,75,000 Annual Cash Flow $ -85,000 $ 35,000 $ 1,25,000 $ 2,35,000 End of Project Cash Flow Total Cash Flow $ -3,75,000 $ -85,000 $ 35,000 $1,25,000 $2,35,000 Discount Factor @ 14% 1.0000 0.8772 0.7695 0.6750 0.5921 Present Value $ -3,75,000 $ -74,561 $ 26,931 $ 84,371 $1,39,139 Net Present Value $ 64,164 Since, the Net Present Value of the Project is Positive, It is recommended to "Accept the Project". $2,35,000 0.5194 $1,22,052 $ 2,35,000 $ 75,000 $3,10,000 0.4556 $1,41,232