Question

CASE 7-32 Net Present Value Analysis of a New Product L07-2 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: a. 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. b. 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 c. 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. d. The devices would sell for $35 each; variable costs for production, administration, and sales would be $15 per unit. Page 393 e. 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.) 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 $180,000 $150,000 $120,000 g. The company's required rate of return is 14%. 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. Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. Would you recommend that Matheson accept the device as a new product?

Answer each question as if you were a consultant hired by Matheson Electronics and are presenting to management as indicated in the case study.

Use outside sources when necessary BUT MAKE SURE YOU CITE THEM!

When giving a recommendation, back it up with numbers and show calculations.

This particular answer should be a management report that no more than two pages in length.

Answer 1

Solution 1:
Annual depreciation on new machine = (Cost - Salvage value) / useful life = ($315,000 - $15,000) / 6 = $50,000

Computation of net cash inflow from sale of device
Particulars	Year 1	Year 2	Year 3	Year 4-6
Sales in units	9000	15000	18000	22000
Sales in dollar	$315,000.00	$525,000.00	$630,000.00	$770,000.00
Variable expenses	$135,000.00	$225,000.00	$270,000.00	$330,000.00
Contribution margin	$180,000.00	$300,000.00	$360,000.00	$440,000.00
Fixed Expenses:
Salaries and other (Excluding depreciation)	$85,000.00	$85,000.00	$85,000.00	$85,000.00
Advertising	$180,000.00	$180,000.00	$150,000.00	$120,000.00
Total fixed expenses	$265,000.00	$265,000.00	$235,000.00	$205,000.00
Net cash inflow (Outflow)	-$85,000.00	$35,000.00	$125,000.00	$235,000.00

Solution 2:

Computation of Net Present Value - Matheson Electronics
Particulars	Now	Year 1	Year 2	Year 3	Year 4	Year 5	Year 6
Cost of equipment	-$315,000
Working capital	-$60,000
Yearly net cash flows		-$85,000	$35,000	$125,000	$235,000	$235,000	$235,000
Release of working capital							$60,000
Salavage value of equipment							$15,000
Total cash flows	-$375,000	-$85,000	$35,000	$125,000	$235,000	$235,000	$310,000
PV Factor	1.000	0.877	0.769	0.675	0.592	0.519	0.456
Present Value	-$375,000	-$74,545	$26,915	$84,375	$139,120	$121,965	$141,360
Net present value	$64,190

Matheson should accept the device as a new product.