Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2789572 • Letter: B
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.
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.)
Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.5 0.7 0.8 0.8 0.6 0.5 0Explanation / Answer
The above is the base case NPV.
Sales = Units x Price
VC = Units x Cost
Depreciation = MACRS (%) x Investment
Cash Flows = Net Income + Depreciation + Investment + NWC + After-tax Salvage Value
Total NWC should be maintained at 10% of next year sales level.
NPV = NPV(10%, 1.6085...1.9929) - 6.55 = $2.6474 million
Now, if NWC is maintained at 5%,
New NPV = $2.7183 million
=> Increase in NPV = $0.0709
Trap 0 1 2 3 4 5 6 MACRS 20% 32% 19.20% 11.52% 11.52% 5.76% Units 0.5 0.7 0.8 0.8 0.6 0.5 Investment -6.3 NWC -0.25 -0.1 -0.05 0 0.1 0.05 0.25 Salvage 0.536 Sales 2.5 3.5 4 4 3 2.5 Costs 0.55 0.77 0.88 0.88 0.66 0.55 Depreciation 1.26 2.016 1.2096 0.72576 0.72576 0.36288 EBT 0.69 0.714 1.9104 2.39424 1.61424 1.58712 Taxes (35%) 0.2415 0.2499 0.66864 0.837984 0.564984 0.555492 Net Income 0.4485 0.4641 1.24176 1.556256 1.049256 1.031628 Cash Flows -6.55 1.6085 2.4301 2.45136 2.382016 1.825016 1.992908 NPV $2.6474Related Questions
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