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 $246,000 and have a six-year useful life. After six years, it would have a salvage value of about $24,000. Sales in units over the next six years are projected to be as follows: YearSales in Units114,000219,000321,0004–623,000 Production and sales of the device would require working capital of $57,000 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 $40 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 $132,000 per year. (Depreciation is based on cost less salvage value.) To gain rapid entry into the market, the company would have to advertise heavily. The advertising costs would be: YearAmount of Yearly Advertising1–2$ 133,0003$ 66,0004–6$ 56,000 The company’s required rate of return is 15%. 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?
Net Present Value
Net present value is the most important concept of finance. It is used to evaluate the investment and financing decisions that involve cash flows occurring over multiple periods. The difference between the present value of cash inflow and cash outflow is termed as net present value (NPV). It is used for capital budgeting and investment planning. It is also used to compare similar investment alternatives.
Investment Decision
The term investment refers to allocating money with the intention of getting positive returns in the future period. For example, an asset would be acquired with the motive of generating income by selling the asset when there is a price increase.
Factors That Complicate Capital Investment Analysis
Capital investment analysis is a way of the budgeting process that companies and the government use to evaluate the profitability of the investment that has been done for the long term. This can include the evaluation of fixed assets such as machinery, equipment, etc.
Capital Budgeting
Capital budgeting is a decision-making process whereby long-term investments is evaluated and selected based on whether such investment is worth pursuing in future or not. It plays an important role in financial decision-making as it impacts the profitability of the business in the long term. The benefits of capital budgeting may be in the form of increased revenue or reduction in cost. The capital budgeting decisions include replacing or rebuilding of the fixed assets, addition of an asset. These long-term investment decisions involve a large number of funds and are irreversible because the market for the second-hand asset may be difficult to find and will have an effect over long-time spam. A right decision can yield favorable returns on the other hand a wrong decision may have an effect on the sustainability of the firm. Capital budgeting helps businesses to understand risks that are involved in undertaking capital investment. It also enables them to choose the option which generates the best return by applying the various capital budgeting techniques.
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