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 $5.4 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 $682,000. 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 $1.30 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 8%. Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.5 0.7 0.8 0.8 0.7 0.5 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.). Change in NPV= ?? million

Explanation / Answer

All cash flows are in millions of dollars Initial Investment 5.4 million salvage value after tax          443,300 (682000 x (1-0.35)) Year 0 1 2 3 4 5 6 Thereafter Sales units(in milions) 0 0.5 0.7 0.8 0.8 0.7 0.5 0 x sales price per unit $5 $5 $5 $5 $5 $5 $5 Sales Revenue $2.5000 $3.5000 $4.0000 $4.0000 $3.5000 $2.5000 $0.0000 Working capital -10% 0.2500 0.3500 0.4000 0.4000 0.3500 0.2500 0.0000 Change in NWC -0.2500 -0.1000 -0.0500 0.0000 0.0500 0.1000 0.2500 Production cost Year 0 1 2 3 4 5 6 Thereafter Sales units(in milions) 0 0.5 0.7 0.8 0.8 0.7 0.5 0 x cost per unit $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 $1.30 Production cost $0.6500 $0.9100 $1.0400 $1.0400 $0.9100 $0.6500 $0.0000 Revenues $2.5000 $3.5000 $4.0000 $4.0000 $3.5000 $2.5000 $0.0000 Expense $0.6500 $0.9100 $1.0400 $1.0400 $0.9100 $0.6500 $0.0000 Depreciation 0.9000 0.9000 0.9000 0.9000 0.9000 0.9000 Pretax profit $0.9500 $1.6900 $2.0600 $2.0600 $1.6900 $0.9500 Tax at 35% 0.3325 0.5915 0.7210 0.7210 0.5915 0.3325 After-tax profit 0.6175 1.0985 1.3390 1.3390 1.0985 0.6175 Cash Flow from operations 1.5175 1.9985 2.2390 2.2390 1.9985 1.5175 Cash Flow: capital invest. -5.4 0.4433 Cash Flow from WC -0.2500 -0.1000 -0.0500 0.0000 0.0500 0.1000 0.2500 Cash Flow from operations 1.5175 1.9985 2.2390 2.2390 1.9985 1.5175 Total Cash Flow -5.6500 1.4175 1.9485 2.2390 2.2890 2.0985 2.2108 PVF at 8% 1 0.925926 0.857339 0.793832 0.73503 0.680583 0.63017 Present Value -5.65 1.3125 1.670525 1.77739 1.682483 1.428204 1.393179 NPV $        3.6143 Change in NWC requirement Year 0 1 2 3 4 5 6 Thereafter Sales units(in milions) 0 0.5 0.7 0.8 0.8 0.7 0.5 0 x sales price per unit $5 $5 $5 $5 $5 $5 $5 Sales Revenue $2.5000 $3.5000 $4.0000 $4.0000 $3.5000 $2.5000 $0.0000 Working capital -10% 0.1250 0.1750 0.2000 0.2000 0.1750 0.1250 0.0000 Change in NWC -0.1250 -0.0500 -0.0250 0.0000 0.0250 0.0500 0.1250 Cash Flow: capital invest. -5.4 0.4433 Cash Flow from WC -0.1250 -0.0500 -0.0250 0.0000 0.0250 0.0500 0.1250 Cash Flow from operations 1.5175 1.9985 2.2390 2.2390 1.9985 1.5175 Total Cash Flow -5.5250 1.4675 1.9735 2.2390 2.2640 2.0485 2.0858 PVF at 8% 1 0.925926 0.857339 0.793832 0.73503 0.680583 0.63017 Present Value -5.525 1.358796 1.691958 1.77739 1.664108 1.394175 1.314408 NPV $        3.6758 change in npv $0.0616 final answer (3.6758 - 3.6143)

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