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:

1. New equipment would have to be acquired to produce the device. The equipment would cost $216,000 and have a six-year useful life. After six years, it would have a salvage value of about $12,000.
2. Sales in units over the next six years are projected to be as follows:

Year	Sales in Units
1	10,000
2	15,000
3	17,000
4–6	19,000

3. Production and sales of the device would require working capital of $53,000 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. The devices would sell for $55 each; variable costs for production, administration, and sales would be $40 per unit.
5. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $120,000 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	$	68,000
3	$	62,000
4–6	$	52,000

7. The company’s required rate of return is 14%.

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?

Answer 1

			year 1	year 2	year 3	year 4-6
incremental contribution margin			150000	225000	255000	285000
incremental fixed cost			154,000	154,000	148,000	138,000
Net cash inflow(outflow)			-4,000	71,000	107,000	147,000

2-a)				Now	1	2	3	4	5	6
	cost of Equipment			-216,000
	Working capital			-53,000
	yearly net cash flows				-4,000	71,000	107,000	147,000	147,000	147,000
	Release of working capital									53,000
	Salvage value of Equipment									12,000
	total cash flows			-269,000	-4000	71000	107000	147000	147000	212000
	discount factor (14%)			1	0.877	0.769	0.675	0.592	0.519	0.456
	present value			-269,000	-3508	54599	72225	87024	76293	96672	114,305
	Net present value			114,305
2-b)	yes

working notes

Depreciation expense
(216000-12000)/6
34000
fixed costs for salaires (cash outflow)=
		120000-34000
		86000
			year 1	year 2	year 3	year 4-6
Sale in units			10,000	15,000	17,000	19,000
Sales in dollars			550000	825000	935000	1045000
variable expenses			400000	600000	680000	760000
contribution margin			150000	225000	255000	285000
Fixed expenses:
Salaries and other			86,000	86,000	86,000	86,000
Advertising			68,000	68,000	62,000	52,000
total fixed expeneses			154,000	154,000	148,000	138,000
Net cash inflow(outflow)			-4,000	71,000	107,000	147,000