Matheson Electronics has just developed a new electronic device that it believes
ID: 2472262 • 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 $318,000 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 $62,000 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 $15 per unit.
Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $169,000 per year. (Depreciation is based on cost less salvage value.)
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Compute the net cash inflow (cash receipts less yearly cash operating expenses) anticipated from sale of the device for each year over the next six years.
Using the data computed in (1) above and other data provided in the problem, determine the net present value of the proposed investment. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.)
Would you recommend that Matheson accept the device as a new product?
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:
Explanation / Answer
From the above information:
Depreciation per year = (318,000 - 18,000) / 6 = $50,000
Also, contribution per unit = $35 -$15 = $20 per unit
Fixed cost incl. depreciation = $169,000 per year
1. Computation of Net cash inflows:
Particulars Year1 Year2 year 3 Year 4 to 6
Sales 8,000 13,000 15,000 17,000
A. Contribution @20 per unit 160,000 260,000 300,000 340,000
B. Less: Fixed costs 169,000 169,000 169,000 169,000
C. Less: Advertising expense 182,000 182,000 51,000 41,000
D. Add: Depreciation 50,000 50,000 50,000 50,000
Net cash inflows:[A-B-C+D ] -141,000 -41,000 130,000 180,000
2. Calculation of Net present value:
Present value of cash outflow i.e asset purchase = - $318,000
Present value of working capital outflow = $62,000
Present value of operating cash inflow @ 8% discount rate for 6 years =
= -141,000 * 0.926 + -41,000*0.857 + 130,000*0.794 + 180,000* 2.046
= $ 305,797
Present value of salvage value at the end of 6th year = 18,000 *0.630 = 11,340
Present value of working capital inflow @ 6th year = $62,000 * 0.630 = 39,060
Net present value = Discounted Cash inflows - Cash outflows
= 305,797 + 11,340 + 39,060 - 318,000 - 62,000
= -23,803
2.B Conclusion : Since, NPV is negative, Matheson should not accept the device for new project