Matheson Electronics has just developed a new electronic device that it believes
ID: 2433203 • Letter: M
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:
New equipment would have to be acquired to produce the device. The equipment would cost $486,000 and have a six-year useful life. After six years, it would have a salvage value of about $24,000.
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 $63,000 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 $159,000 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 18%.
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 18,000 2 23,000 3 25,000 4–6 27,000Explanation / Answer
Depreciation expense (486000-24000)/6 77000 fixed costs for salaires (cash outflow)= 159000-77000 82000 year 1 year 2 year 3 year 4-6 Sale in units 18,000 23,000 25,000 27,000 Sales in dollars 630000 805000 875000 945000 variable expenses 360000 460000 500000 540000 contribution margin 270000 345000 375000 405000 Fixed expenses: Salaries and other 82,000 82,000 82,000 82,000 Advertising 228,000 228,000 72,000 62,000 total fixed expeneses 310,000 310,000 154,000 144,000 Net cash inflow(outflow) -40,000 35,000 221,000 261,000 2-a) Now 1 2 3 4 5 6 cost of Equipment -486,000 Working capital -63,000 yearly net cash flows -40,000 35,000 221,000 261,000 261,000 261,000 Release of working capital 63,000 Salvage value of Equipment 24,000 total cash flows -549,000 -40000 35000 221000 261000 261000 348000 discount factor (18%) 1 0.847 0.718 0.609 0.516 0.437 0.37 present value -549,000 -33880 25130 134589 134676 114057 128760 Net present value -45,668 2-b) No