CASE 14-32 Net Present Value Analysis of a New Product L014-2 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. After six years, it would have a salvage value of about $15,000. Sales in units over the next six years are projected to be as follows: a. Capital Budgeting Decisions 681 Year Sales In Units 1 2 3 4-6 9,000 15,000 18,000 22,000 c. d 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, adninistration, and sales would be $15 per unit. 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 adver- tising costs would be: e. f. Year 1-2 3 4-6 Amount of Yearly Advertising $180,000 $150,000 $120,000 The company's required rate of return is 14%. 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. Using the data computed in (1) above and other data provided in the problem, determine the niet present value of the proposed investment. Would you recommend that Matheson accept the device as a new product? Appendix 14A: The Concept of Present Value A dollat received today is more valuable than a dollar received a year from now for the simple reason that if you have a dollar today, you can put it in the bank and have more than a dollar a year from now. Because dollars today are worth more than dollars in the future, cash flows that are received at different times must be valued differently. LO14-7 Understand present value concepts and the use of present value tables, The Mathematics of Interest If a bank pays 5% interest, then a deposit of $100 today will be worth S105 one year from now. This can be expressed as follows: Fi = P(1 + r) (1) where Fl = the balance at the end of one period, P = the amount invested now, and r= the rate of interest per period. In the case where $100 is deposited in a savings account that earns 5% interest, P = $100 and r = 0.05. Under these conditions, FI = $105. The $100 present outlay is called the present value of the S105 amount to be received in one year. It is also known as the discounted value of the future $105 receipt. The $100 represents the value in present terms of $105 to be received a year from now when the interest rate is 5%