Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.7 million. The equipment will be depreciated straight-line over 6 years, but, in fact, it can be sold after 6 years for $671,000. 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 $1.80 per trap and believes that the traps can be sold for $8 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 40%, and the required rate of return on the project is 11%.

Year:	0	1	2	3	4	5	6	Thereafter
Sales (millions of traps)	0	0.4	0.5	0.7	0.7	0.5	0.3	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? (Do not round your intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

Answer 1

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NPV using current scenario = $4,099,576.82

NPV using New Scenario = $4,196,211.16

Increase in NPV = NPV using New Scenario - NPV using current scenario

= $4,196,211.16 - $4,099,576.82

= $96,634.34

Therefore, Increase in NPV is $96,634.34

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Calculation of NPV using Old Scenario

Particulars	Year (n)
0	1	2	3	4	5	6
Initial Investment
Investment in Equipment (A)	-5700000
Operating Cashflows
Sales Revenue (B) Y1: 400000 traps * $8 per trap Y2: 500000 traps * $8 per trap Y3: 700000 traps * $ 8 per trap Y4: 700000 traps * $ 8 per trap Y5: 500000 traps * $ 8 per trap Y6: 300000 traps * $ 8 per trap		3200000	4000000	5600000	5600000	4000000	2400000
Less: Production Cost (C ) Y1: 400000 traps * $1.8 per trap Y2: 500000 traps * $1.8 per trap Y3: 700000 traps * $1.8 per trap Y4: 700000 traps * $1.8 per trap Y5: 500000 traps * $1.8 per trap Y6: 300000 traps * $1.8 per trap		720000	900000	1260000	1260000	900000	540000
Less: Depreciation (D) ($5700000/6 years)		950000	950000	950000	950000	950000	950000
Profit Before Tax (E = B-C-D)		1530000	2150000	3390000	3390000	2150000	910000
Less: Tax @40% (F = E*40%)		612000	860000	1356000	1356000	860000	364000
Profit After Tax (G = E-F)		918000	1290000	2034000	2034000	1290000	546000
Addback Depreciation (H = D)		950000	950000	950000	950000	950000	950000
Net Operating Cashflows (I = G+H)		1868000	2240000	2984000	2984000	2240000	1496000
Investment in Working Capital
Investment in Working Capital	-320000	-400000	-560000	-560000	-400000	-240000	0
Working Capital Already Invested	0	-320000	-400000	-560000	-560000	-400000	-240000
Net Investment in Working Capital (J)	-320000	-80000	-160000	0	160000	160000	240000
Terminal Cashflow
Sale Value of Equipment (K)							671000
Less: Tax @40% (L = K*40%)							268400
Net Sale value of the Equipment (M = K-L)							402600
Total Cashflows (N = A+I+J)	-6020000	1788000	2080000	2984000	3144000	2400000	2138600
Discounting Factor 11%	1	0.900901	0.811622	0.731191	0.658731	0.593451	0.534641
Discounted Cashflows	-6020000	1610811	1688175	2181875	2071050	1424283	1143383
Net Present Value	4099576.816

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Calculation of NPV using New Scenario

Particulars	Year (n)
0	1	2	3	4	5	6
Initial Investment
Investment in Equipment (A)	-5700000
Operating Cashflows
Sales Revenue (B) Y1: 400000 traps * $8 per trap Y2: 500000 traps * $8 per trap Y3: 700000 traps * $ 8 per trap Y4: 700000 traps * $ 8 per trap Y5: 500000 traps * $ 8 per trap Y6: 300000 traps * $ 8 per trap		3200000	4000000	5600000	5600000	4000000	2400000
Less: Production Cost (C ) Y1: 400000 traps * $1.8 per trap Y2: 500000 traps * $1.8 per trap Y3: 700000 traps * $1.8 per trap Y4: 700000 traps * $1.8 per trap Y5: 500000 traps * $1.8 per trap Y6: 300000 traps * $1.8 per trap		720000	900000	1260000	1260000	900000	540000
Less: Depreciation (D) ($5700000/6 years)		950000	950000	950000	950000	950000	950000
Profit Before Tax (E = B-C-D)		1530000	2150000	3390000	3390000	2150000	910000
Less: Tax @40% (F = E*40%)		612000	860000	1356000	1356000	860000	364000
Profit After Tax (G = E-F)		918000	1290000	2034000	2034000	1290000	546000
Addback Depreciation (H = D)		950000	950000	950000	950000	950000	950000
Net Operating Cashflows (I = G+H)		1868000	2240000	2984000	2984000	2240000	1496000
Investment in Working Capital
Investment in Working Capital	-160000	-200000	-280000	-280000	-200000	-120000	0
Working Capital Already Invested	0	-160000	-200000	-280000	-280000	-200000	-120000
Net Investment in Working Capital (J)	-160000	-40000	-80000	0	80000	80000	120000
Terminal Cashflow
Sale Value of Equipment (K)							671000
Less: Tax @40% (L = K*40%)							268400
Net Sale value of the Equipment (M = K-L)							402600
Total Cashflows (N = A+I+J)	-5860000	1828000	2160000	2984000	3064000	2320000	2018600
Discounting Factor 11%	1	0.900901	0.811622	0.731191	0.658731	0.593451	0.534641
Discounted Cashflows	-5860000	1646847	1753104	2181875	2018352	1376807	1079226
Net Present Value	4196211.16