AFM481 Lecture Notes - Lecture 4: Fax, Scientific Method, Risk Perception
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PLEASE ANSWER ALL PARTS IN ORDER TO RECIEVE A REVIEW, THANKYOU.
Matheson Electronics has just developed a new electronic devicethat it believes will have broad market appeal. The company hasperformed marketing and cost studies that revealed the followinginformation: |
a. | New equipment would have to be acquired to produce the device.The equipment would cost $216,000 and have a six-year useful life.After six years, it would have a salvage value of about$12,000. |
b. | Sales in units over the next six years are projected to be asfollows: |
Year | Sales inUnits |
1 | 10,000 |
2 | 15,000 |
3 | 17,000 |
4â6 | 19,000 |
c. | Production and sales of the device would require working capitalof $53,000 to finance accounts receivable, inventories, andday-to-day cash needs. This working capital would be released atthe end of the projectâs life. |
d. | The devices would sell for $55 each; variable costs forproduction, administration, and sales would be $40 per unit. |
e. | Fixed costs for salaries, maintenance, property taxes,insurance, and straight-line depreciation on the equipment wouldtotal $120,000 per year. (Depreciation is based on cost lesssalvage value.) |
f. | To gain rapid entry into themarket, the company would have to advertise heavily. Theadvertising program would be: |
Year | Amount of Yearly Advertising | ||
1â2 | $ | 82,000 | |
3 | $ | 62,000 | |
4â6 | $ | 52,000 | |
g. | The companyâs required rate ofreturn is 14%. |
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determinethe appropriate discount factor(s) using tables. |
Required: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
1. | Compute the net cash inflow (cash receipts less yearly cashoperating expenses) anticipated from sale of the device for eachyear over the next six years. | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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2-a. | Using the data computed in (1) above and other data provided inthe problem, determine the net present value of the proposedinvestment. (Any cash outflows should be indicated by aminus sign. Round discount factor(s) to 3 decimalplaces.) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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2-b. | Would you recommend that Matheson accept the device as a newproduct? | ||||
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Part-A
Scenario:
Midal cables limited, is currently considering the launch of anew product. A market survey was recently commissioned to assessthe likely demand for the product and this showed that the producthas an expected life of four years. The survey cost $30,000 andthis is due for payment in four monthsâ time. On the basis of thesurvey information as well as internal management accountinginformation relating to costs, the assistant accountant preparedthe following profit forecasts for the product.
Year | 1 | 2 | 3 | 4 |
$'000 | $'000 | $'000 | $'000 | |
Sales | 180 | 200 | 160 | 120 |
Cost of sales | (115) | (140) | (110) | (85) |
Gross profit | 65 | 60 | 50 | 35 |
Variable overheads | (27) | (30) | (24) | (18) |
Fixed overheads | (25) | (25) | (25) | (25 |
Market survey written off | (30) | |||
Net profit/(loss) | (17) | 5 | 1 | (8) |
These profit forecasts were viewed with disappointment by thedirectors and there was a general feeling that the new productshould not be launched. The Chief Executive pointed out that theproduct achieved profits in only two years of its four-year lifeand that over the four-year period as a whole, a net loss wasexpected. However, before a meeting that had been arranged todecide formally the future of the product, the following additionalinformation became available:
The new product will require the use of an existing machine.This has a written down value of$80,000 but could be sold for$70,000 immediately if the new product is not launched. If theproduct is launched, it will be sold at the end of the four-yearperiod for $10,000.
Additional working capital of $20,000 will be requiredimmediately and will be needed over the four-year period. It willbe released at the end of the period.
The fixed overheads include a figure of $15,000 per year fordepreciation of the machine and $5,000 per year for there-allocation of existing overheads of the business.
The company has a cost of capital of 10%.
Ignore taxation.
Required
Use integrated financial software you are familiar with andperform the task below. For example, you may use excelspreadsheet for calculation and presentation of cash flowand Microsoft word to explain the phenomenon.
Calculate the incremental cash flows arising from a decision tolaunch the product.
Calculate the approximate internal rate of return of theproduct.
Explain, with reasons, whether or not the product should belaunched. (50-100 words)