Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2715976 • Letter: B
Question
Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.7 million. The equipment will be depreciated straight line over 6 years to a value of zero, but in fact it can be sold after 6 years for $638,000. The firm believes that working capital at each date must be maintained at a level of 15% of next year’s forecast sales. The firm estimates production costs equal to $1.70 per trap and believes that the traps can be sold for $8 each. Sales forecasts are given in the following table. The project will come to an end in 6 years., when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 10%. Use the MACRS depreciation schedule.
Year: 0 1 2 3 4 5 6 Thereafter
Sales (millions of traps) 0 .5 .6 .8 .8 .6 .4 0
Suppose the firm can cut its requirements for working capital in half by using better inventory control systems. By how much will this increase project NPV? (Enter your answer in millions rounded to 4 decimal places.)
NPV $ million
Explanation / Answer
Units Sales cost cash inflow 8 1.7 Cash Inflow (dep) CF After Dep (tax)35% CF After tax add dep CF after tax before dep PV @10% Present value of cash inflows 500000 4000000 850000 3150000 1012400 2137600 748160 1389440 1012400 2401840 0.909 2183272.6 600000 4800000 1020000 3780000 1619840 2160160 756056 1404104 1619840 3023944 0.826 2497777.7 800000 6400000 1360000 5040000 971904 4068096 1423834 2644262 971904 3616166 0.751 2715741 800000 6400000 1360000 5040000 583142.4 4456858 1559900 2896957 583142.4 3480100 0.683 2376908.2 600000 4800000 1020000 3780000 583142.4 3196858 1118900 2077957 583142.4 2661100 0.621 1652543 400000 3200000 680000 2520000 291571.2 2228429 779950.1 1448479 291571.2 1740050 0.564 981388.15 Scrap value 638000 0.564 359832 recovery of working capital 15910800 0.564 8973691.2 Sum of discounted cash inflow 21741154 Outflow of fund 10140000 NPV of the Project 11601154 NPV of the project is Positive so should be accepted 5062000 Calculation of depreciation cost Amount of Deprication 20% 5062000 1012400 32 5062000 1619840 19.20% 5062000 971904 11.52% 5062000 583142.4 11.52% 5062000 583142.4 5.76% 5062000 291571.2 Outflow of funds Years cash outflow Working capital requirement (15% of estimated sale) Working capital requirement (15% of estimated sale) PV@10% Total Investment in working capital (present value) Total cash outflow 0 5700000 600000 0 0 6300000 1 720000 0.909 654480 720000 2 960000 0.826 792960 960000 3 960000 0.751 720960 960000 4 720000 0.683 491760 720000 5 480000 0.621 298080 480000 6 Total outflow 10140000 Investment in working Capital 3558240 If workng Capital reduced by half Outflow of funds Years cash outflow Working capital requirement (15% of estimated sale) Working capital requirement (15% of estimated sale)half PV@10% Total Investment in working capital (present value) Total cash outflow 0 5700000 300000 0 0 6000000 1 360000 0.909 327240 360000 2 480000 0.826 396480 480000 3 480000 0.751 360480 480000 4 360000 0.683 245880 360000 5 240000 0.621 149040 240000 6 Total outflow 7920000 Investment in working Capital 1779120 Years CF after tax before dep PV @10% Present value of cash inflows 1 2401840 0.909 2183273 2 3023944 0.826 2497778 3 3616166 0.751 2715741 4 3480100 0.683 2376908 5 2661100 0.621 1652543 6 1740050 0.564 981388.2 638000 0.564 359832 2220000 0.564 1252080 Sum of discounted cash inflow 14019543 Outflow of fund 7920000 NPV of the Project 6099543 If working capital requirement is reduced by 50% then project would have positive NPV and it would be accepted NPV of the Project 11601154 NPV of the project after reducing the working capital requirement by 50% 6099543
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