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:a. New equipment would have to be acquired to produce the device. The equipment would cost $228,000 and have a six-year useful life. After six years, it would have a salvage value of about $24,000.b. Sales in units over the next six years are projected to be as follows:Year Sales in Units1 14,0002 19,0003 21,0004–6 23,000c. Production and sales of the device would require working capital of $55,000 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.d. The devices would sell for $30 each; variable costs for production, administration, and sales would be $15 per unit.e. Fixed costs for salaries, maintenance, property taxes, insurance, and straight-line depreciation on the equipment would total $179,000 per year. (Depreciation is based on cost less salvage value.)f. To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be:Year Amount of YearlyAdvertising1–2 $ 78,000 3 $ 64,000 4–6 $ 54,000 g. 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?

Answer 1

Answer:

See the attached solved image.

Explanation:

We assume that the fixed costs other than depreciation are all incremental as there is no metric to tell them apart.

The project should be accepted as it nets a positive NPV at the end of the project life of 6 years.

Hope that helps.

Answer 2

Yes, I would recommend that Matheson accept the device as a new product because it has a positive net present value (NPV).

What is CBA?

CBA is an acronym for cost-benefit analysis and it can be defined as a financial technique (utilitarianism) which is used by individuals, business firms and government to examine and compare the cost that is associated with a product, project or task and the benefits that would be derived from it.

This ultimately implies that, cost-benefit analysis can be used by an account or economist to determine how changes in differing levels of activities such as costs and volume affect a business firm's operating income and net income.

In this scenario, we would use cost-benefit analysis (CBA) to compare the net present value (NPV) of the cost of this new electronic device with the net present value (NPV) of its benefits by using an Excel spreadsheet formula.

For the depreciation expense (add back depreciation), we have:

$Depreciation =\frac{Equipment\;cost - Salvage \;value}{time} \\\\Depreciation =\frac{228000 - 24000}{6}$

Depreciation = $34,000.

For the cash outflow (fixed cost for salaries), we have:

$Cash\;flow = TFC -Depreciation\\\\Cash\;flow = 179000-34000$

Cash flow = $145,000.

Based on the calculations, the net present value (NPV) of the device is equal to $75,584 and as such I would recommend that Matheson accept the device as a new product.

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