Better Mousetraps has developed a new trap. The company has already conducted a

Question

Better Mousetraps has developed a new trap. The company has already conducted a feasibility study at a cost of $100,000 to ensure that the new trap would work, and it has indicated no problem. It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated straight-line over 5 years to a book value of zero. The firm estimates variable costs equal to $1.50 per trap and believes that the traps can be sold for $4 each. The fixed costs are $300,000 per year. Financing costs for the project are $250,000 per year. Sales are expected to be 1 million traps per year. The project will come to an end in 5 years, when the equipment is expected to have a market value of $1 million. The project requires an immediate increase in inventory of $500,000, an increase in accounts receivable of $300,000, and an increase in accounts payable of $600,000. This investment in net working capital will be recovered at the end of the five years. The firm's tax bracket is 35%, and the cost of capital on the project is 12%. Please calculate the project's NPV and IRR. Conduct the scenario analysis of NPV to variable costs and unit sales, letting variable cost vary from $1.2 to $1.9 per trap in increments of $0.1 per trap and letting unit sales vary from 800,000 to 1,200,000 per year in increments of 100,000 units at the same time. At least how many traps need to be sold if the project breaks even on the NPV basis? In other words, at least how many traps need to be sold that makes the NPV of the project turns positive?

Explanation / Answer

Step 1:

Step 2 :

Working capital calculation = inventory + acc receivable - acc payables = 500000+300000-600000 = 200000

To compute the IRR of the project we need to discount at lower rate because at 12% NPV is negative and hence IRR is the rate at which NPV becomes zero

`Since the NPV is close to zero at 11.35% hence the IRR of the project is 11.35%

The traps to be sold so that the breakeven at NPV then

At the above table the net present value is arrived by increasing the traps production and sold 1.02 million hence increased 20,000 therefore we get net present value positive 14000 . Hence to bring the npv to zero 14000/profit(4-1.5) hence the total number of trap should be sold = 1 million +(20,000 - 5600 ) = 1144000 .

thank you.

Particulars(Formulas) 1 2 3 4 5 sales(1million*4 per piece) 4000000 4000000 4000000 4000000 4000000 variable cost(1million *1.5) 1500000 1500000 1500000 1500000 1500000 Gross profit(sales-variable) 2500000 2500000 2500000 2500000 2500000 depreciation (6million/5) 1200000 1200000 1200000 1200000 1200000 Fixed cost 300000 300000 300000 300000 300000 financing cost 250000 250000 250000 250000 250000 profit before tax 750000 750000 750000 750000 750000 Tax 35% 262500 262500 262500 262500 262500 Profit after tax 487500 487500 487500 487500 487500 Cash flow(Profit+depreciation) 1687500 1687500 1687500 1687500 1687500

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