Matheson Electronics has ust developed a new electronc devke that t believes wil
ID: 2515907 • Letter: M
Question
Matheson Electronics has ust developed a new electronc devke that t believes wil have broad market appeat. The company tas performed marketing and cost studies that revealed the tollowir information a. Newr equipment would have to be acquired to produce the device. The equipment wouid cost $240,000 and have a six-year useful life. After six years, t wouid have a savage value of about $18,000 b. Sales in units over the next sx years are projected to be as follows s in 13.000 18,000 20,000 22,000 4-6 c Production and saies of the device would require working captai of $56.000 to tinance accounts receivable inventores, and day to-day cash needs This working captal would be released at t end of the project's Ife d The devices would sell for $35 each, variable costs for production, administration, and saies would be $20 per unt e Fised costs tor salaries martenance. property taxes. nsrance and straighane de retation on the equip r wad ital Sts, oo???, year value) e ecat on is base , on cost lens utva e f To gain rapid entry into the market the company would have to advertise heavily The advertising program would be Amount of Yealy Year 5 85,000 65,000 $56,000 4-6 g The companys required rate or return as ,7% cck here to viEahibit atu.t andto eteme tepropniale dincount ctorsuiExplanation / Answer
Solution:
Part 1 – Computation of Net Cash Inflow (outflow)
Year 1
Year 2
Year 3
Year 4-6
Sales in units
13,000
18,000
20,000
22,000
Sales in dollars (Sales units @ $35)
$455,000
$630,000
$700,000
$770,000
Variable Expenses (Sales unit @ $20)
$260,000
$360,000
$400,000
$440,000
Contribution Margin
$195,000
$270,000
$300,000
$330,000
Fixed Expenses:
Salaries and other (refer note)
$114,000
$114,000
$114,000
$114,000
Advertising
$85,000
$85,000
$65,000
$55,000
Total Fixed Expenses
$199,000
$199,000
$179,000
$169,000
Net Cash Inflow (Outflow)
-$4,000
$71,000
$121,000
$161,000
Note --
Annual Depreciation = (Cost of Equipment 240,000 – Salvage Value $18,000) / useful life 6
= $37,000
Depreciation is a non cash item. It means depreciation does not involve any cash outflow, hence it is not deducted from the contribution margin to get net cash inflows from the project.
Since tax rate is not given in the question, there is no need to deduct the depreciation. We deduct the depreciation only to get the benefit in tax and added back to net profit to get Net Cash Inflows.
Part 2(a) – Net Present Value
Now
Year 1
Year 2
Year 3
Year 4
Year 5
Year 6
Cost of Equipment
($240,000)
Working Capital
($56,000)
Yearly Net Cash Flows
($4,000)
$71,000
$121,000
$161,000
$161,000
$161,000
Release of working capital
$56,000
Salvage value of equipment
$18,000
Total Cash flows
-$296,000
-$4,000
$71,000
$121,000
$161,000
$161,000
$235,000
Discount factor @ 17%
1.000
0.855
0.731
0.624
0.534
0.456
0.390
Present Value
-$296,000
-$3,420
$51,901
$75,504
$85,974
$73,416
$91,650
Net Present Value
$79,025
Part 2(b) – Yes the project should be selected. Since the NPV is positive.
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Year 1
Year 2
Year 3
Year 4-6
Sales in units
13,000
18,000
20,000
22,000
Sales in dollars (Sales units @ $35)
$455,000
$630,000
$700,000
$770,000
Variable Expenses (Sales unit @ $20)
$260,000
$360,000
$400,000
$440,000
Contribution Margin
$195,000
$270,000
$300,000
$330,000
Fixed Expenses:
Salaries and other (refer note)
$114,000
$114,000
$114,000
$114,000
Advertising
$85,000
$85,000
$65,000
$55,000
Total Fixed Expenses
$199,000
$199,000
$179,000
$169,000
Net Cash Inflow (Outflow)
-$4,000
$71,000
$121,000
$161,000