Matheson Electronics has just developed a new electronic device that it believes
ID: 2540256 • 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 $120,000 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 $44,000 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 $45 each; variable costs for production, administration, and sales would be $25 per unit.
Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $132,000 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 15%.
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?
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. (Negative amounts should be indicated by a minus sign.)
Year Sales in Units 1 6,000 2 11,000 3 13,000 4–6 15,000Explanation / Answer
selling price per unit
45
variable cost
25
year
0
1
2
3
4
5
6
sales in units
6000
11000
13000
15000
15000
15000
sales in dollars = units*selling price
270000
495000
585000
675000
675000
675000
less variable cost in dollars = units sold*variable cost per unit
150000
275000
325000
375000
375000
375000
contribution margin
120000
220000
260000
300000
300000
300000
lessfixed cost for salaries and others except depreciation) = 132000-17000
115000
115000
115000
115000
115000
115000
less advertising expense
74000
74000
53000
43000
43000
43000
total operating expenses
189000
189000
168000
158000
158000
158000
1-
net cash inflow
-69000
31000
92000
142000
142000
142000
Annual depreciation
cost of machine-scrap value / life of machine
(120000-18000)/6
17000
2-
cash outflow
cost of machine
-120000
additional working capital
-44000
total cash outflow
-164000
cash inflow in year 6
net cash inflow + recovery of working capital+scrap value of machine
142000+44000+18000
204000
Year
net cash flow
present value factor at 15% = 1/(1+r)^n r =15%
present value of cash flow = net cash flow*present value factor
0
-164000
1
-164000
1
-69000
0.869565
-60000
2
31000
0.756144
23440.45
3
92000
0.657516
60491.49
4
142000
0.571753
81188.96
5
142000
0.497177
70599.1
6
204000
0.432328
88194.83
Net present value
sum of present value of net cash flow
99914.83
Yes he should accept the device as NPV is positive
selling price per unit
45
variable cost
25
year
0
1
2
3
4
5
6
sales in units
6000
11000
13000
15000
15000
15000
sales in dollars = units*selling price
270000
495000
585000
675000
675000
675000
less variable cost in dollars = units sold*variable cost per unit
150000
275000
325000
375000
375000
375000
contribution margin
120000
220000
260000
300000
300000
300000
lessfixed cost for salaries and others except depreciation) = 132000-17000
115000
115000
115000
115000
115000
115000
less advertising expense
74000
74000
53000
43000
43000
43000
total operating expenses
189000
189000
168000
158000
158000
158000
1-
net cash inflow
-69000
31000
92000
142000
142000
142000
Annual depreciation
cost of machine-scrap value / life of machine
(120000-18000)/6
17000
2-
cash outflow
cost of machine
-120000
additional working capital
-44000
total cash outflow
-164000
cash inflow in year 6
net cash inflow + recovery of working capital+scrap value of machine
142000+44000+18000
204000
Year
net cash flow
present value factor at 15% = 1/(1+r)^n r =15%
present value of cash flow = net cash flow*present value factor
0
-164000
1
-164000
1
-69000
0.869565
-60000
2
31000
0.756144
23440.45
3
92000
0.657516
60491.49
4
142000
0.571753
81188.96
5
142000
0.497177
70599.1
6
204000
0.432328
88194.83
Net present value
sum of present value of net cash flow
99914.83
Yes he should accept the device as NPV is positive