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 $294,000 and have a six-year useful life. After six years, it would have a salvage value of about $6,000 b. Sales in units over the next six years are projected to be as follows: Year Sales in Units 6,000 11,000 13,000 15,000 c. Production and sales of the device would require working capital of $45,000 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 $50 each; variable costs for production, administration, and sales would be $30 per unit. e. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $171,000 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: Year 1-2 Amount of Yearly Advertising $74,000 $54,000 $44.000 g. The company's required rate of return is 8%.

Answer 1

Part 1

	Year
	1	2	3	4-6
Sales in units	6000	11000	13000	15000
Sales in dollars ($50 each)	300000	550000	650000	750000
Variable expenses ($30 each)	180000	330000	390000	450000
Incremental contribution margin	120000	220000	260000	300000
Incremental fixed expenses:
Salaries and other	123000	123000	123000	123000
Advertising	74000	74000	54000	44000
Total fixed expenses	197000	197000	177000	167000
Net cash inflow (outflow)	(77000)	23000	83000	133000

Depreciation not being a cash expense should be eliminated

Depreciation = (294000-6000)/6 = 48000

171000-48000 = $123000

Part 2 a

	Now	1	2	3	4	5	6
Cost of equipment	(294000)
Working capital	(45000)
Yearly net cash flows		(77000)	23000	83000	133000	133000	133000
Release of working capital							45000
Salvage value of equipment							6000
Total cash flows (a)	(339000)	(77000)	23000	83000	133000	133000	184000
Discount factor (8%) (b)	1.00	0.926	0.857	0.794	0.735	0.681	0.630
Present value (a)×(b)	(339000)	(71302)	19711	65902	97755	90573	115920
Net present value	$(20441)

Part 2 B

No, Matheson should not accept the device as a new product because the NPV is negative