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 $672,000. 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 $1.70 per trap and believes that the traps can be sold for $7 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 9%.

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.)

Answer 1

Change in NPV = 0.0940 million

WORKINGS

Original NPV = $ 5.7059 million

Year	Sales	Costs	Depreciation	Profit before tax	Tax	Net Income	OCF	WC Required	Change in WC	Initial cost	After tax salvage	Net CF
0								0.35	-0.35	-6.3		-6.65
1	3.5	0.85	1.05	1.6	0.56	1.04	2.09	0.49	-0.14			1.95
2	4.9	1.19	1.05	2.66	0.931	1.729	2.779	0.56	-0.07			2.709
3	5.6	1.36	1.05	3.19	1.1165	2.0735	3.1235	0.56	0			3.1235
4	5.6	1.36	1.05	3.19	1.1165	2.0735	3.1235	0.49	0.07			3.1935
5	4.9	1.19	1.05	2.66	0.931	1.729	2.779	0.35	0.14			2.919
6	3.5	0.85	1.05	1.6	0.56	1.04	2.09		0.35		0.4368	2.8768

NPV after change = $5.7999 m

Year	Sales	Costs	Depreciation	Profit before tax	Tax	Net Income	OCF	WC Required	Change in WC	Initial cost	After tax salvage	Net CF
0								0.175	-0.175	-6.3		-6.475
1	3.5	0.85	1.05	1.6	0.56	1.04	2.09	0.245	-0.07			2.02
2	4.9	1.19	1.05	2.66	0.931	1.729	2.779	0.28	-0.035			2.744
3	5.6	1.36	1.05	3.19	1.1165	2.0735	3.1235	0.28	0			3.1235
4	5.6	1.36	1.05	3.19	1.1165	2.0735	3.1235	0.245	0.035			3.1585
5	4.9	1.19	1.05	2.66	0.931	1.729	2.779	0.175	0.07			2.849
6	3.5	0.85	1.05	1.6	0.56	1.04	2.09		0.175		0.4368	2.7018
											NPV	5.7999