Matheson Electronics has just developed a new electronic device 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 $315,000 and have a six-year useful life.
Matheson Electronics has just developed a new electronic device it believes will have broad market appeal. The company has performed marketing and cost studies that revealed the following information:
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New equipment would have to be acquired to produce the device. The equipment would cost $315,000 and have a six-year useful life. After six years, it would have a salvage value of about $15,000.
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Sales in units over the next six years are projected to be as follows:
Year
Sales in Units
1
9,000
2
15,000
3
18,000
4–6
22,000
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Production and sales of the device would require
working capital of $60,000 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.
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Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line
depreciation on the equipment would total $135,000 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:
Year
Amount of Yearly
Advertising1–2
$180,000
3
$150,000
4–6
$120,000
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The company’s required
rate of return is 14%.
Required:
-
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. -
Using the data computed in (1) above and other data provided in the problem, determine the
net present value of the proposed investment. Would you recommend that Matheson accept the device as a new product?
Net cash flow refers to either the gain or loss of funds over a period (after all debts have been paid). When a business has a surplus of cash after paying all its operating costs, it is said to have a positive cash flow.
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