Better Mousetraps has developed a new trap. It can go into production for an ini

Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6.3 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 $536,000. The firm believes that working capital at each date must be maintained at a level of 10% of next year’s forecast sales. The firm estimates production costs equal to $1.10 per trap and believes that the traps can be sold for $5 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 .7 .8 .8 .6 .5 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

Solution:

We need to compute the cash flows in step 1:

Step 2:

To compute the NPV of the project :

I have considered the workign capital in step 2:

Working capital to be 10% of nexyt year sales hence in year 0 the initial cost = -6.3 million + 10% of 2.5 = -6.55

similarly for year 2 = cash flow - 10% of next year sales +10% of previous year

Hence the NPV is computed as :

In $ millions 1 2 3 4 5 6 Particulars/Formula Sales($5*units sold) 2.5 3.5 4 4 3 2.5 Variable cost($1.10* units) 0.55 0.77 0.88 0.88 0.66 0.55 Gross profit 1.95 2.73 3.12 3.12 2.34 1.95 Depreciation rate 20% 32% 19.20% 11.52% 11.52% 5.76% 6.36million*MACRS rate 1.272 2.0352 1.22112 0.732672 0.732672 0.366336 Profit 0.678 0.6948 1.89888 2.387328 1.607328 1.583664 Tax 35% 0.2373 0.24318 0.664608 0.8355648 0.5625648 0.5542824 Profit after tax 0.4407 0.45162 1.234272 1.5517632 1.0447632 1.0293816 CAsh flows = profit+depreciation 1.7127 2.48682 2.455392 2.2844352 1.7774352 1.3957176

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