Matheson Electronics has just developed a new electronic dev

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 $240,000 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:

Production and sales of the device would require working capital of $56,000 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 $35 each; variable costs for production, administration, and sales would be $20 per unit.

Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $151,000 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:

The company’s required rate of return is 17%.

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?

Year	Sales in Units
1	13,000
2	18,000
3	20,000
4–6	22,000

Solution

1) Year 1 2 3 4 5 6 Sales in Units 13000 18000 20000 22000 22000 22000 Sales In Dollars @ $35 $455,000.00 $630,000.00 $700,000.00 $770,000.00 $770,000.00 $770,000.00 Less: Variable Expenses @ $20 $260,000.00 $360,000.00 $400,000.00 $440,000.00 $440,000.00 $440,000.00 Contribution margin $195,000.00 $270,000.00 $300,000.00 $330,000.00 $330,000.00 $330,000.00 Less: Fixed expenses: Salaries and other ($151,000 - ($240,000 -$18000)/6) $114,000.00 $114,000.00 $114,000.00 $114,000.00 $114,000.00 $114,000.00 Advertising $128,000.00 $128,000.00 $65,000.00 $55,000.00 $55,000.00 $55,000.00 Total fixed expenses $242,000.00 $242,000.00 $179,000.00 $169,000.00 $169,000.00 $169,000.00 Net cash inflow (outflow) -$47,000.00 $28,000.00 $121,000.00 $161,000.00 $161,000.00 $161,000.00 2) Initial Cash flow Equipment -$240,000.00 Add: Net working Capital -$56,000.00 Cashflow at year 0 -$296,000 Cash flow at year 6 = $18000 + $161,000+ 56000 $235,000 Year Cash Flow PV @17% Present Value 0 -$296,000.00 1.000 -$296,000.00 1 -$47,000.00 0.855 -$40,170.94 2 $28,000.00 0.731 $20,454.38 3 $121,000.00 0.624 $75,548.84 4 $161,000.00 0.534 $85,917.66 5 $161,000.00 0.456 $73,433.90 6 $235,000.00 0.390 $91,612.07 NPV $10,795.90 2-b) Matheson would accept the device as a new product because NPV is positive. This is calculated using PV table figures. Year Cash Flow 0 -$296,000.00 1 -$296,000.00 1 -$47,000.00 0.8547 -$40,170.90 2 $28,000.00 0.7305 $20,454.00 3 $121,000.00 0.6244 $75,552.40 4 $161,000.00 0.5337 $85,925.70 5 $161,000.00 0.4561 $73,432.10 6 $235,000.00 0.3898 $91,603.00 $10,796.30