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 $549,000. 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 $1.60 per trap and believes that the traps can be sold for $6 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%.

Year	0	1	2	3	4	5	6	thereafter
Sales (Millions of traps)	0	0.6	0.8	1.0	1.0	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? (Enter your answer in millions rounded to 4 decimal places.)

Change in NPV?

Answer 1

Statement showing WC requirement

Particulars	0	1	2	3	4	5	6
Sales units	0	600000	800000	10000000	10000000	500000	300000
Sales price per unit		6	6	6	6	6	6
Total sales		3600000	4800000	60000000	60000000	3000000	1800000
WC requirement	360000	480000	6000000	6000000	300000	180000	0
Increase In WC	360000	120000	5520000	0	-5700000	-120000	-180000
Change in cash	-360000	-120000	-5520000	0	5700000	120000	180000

Statement showing NPV

Particulars	0	1	2	3	4	5	6	NPV
Initial investment	-6300000
SPPU		6	6	6	6	6	6
VCUP		1.6	1.6	1.6	1.6	1.6	1.6
CPU		4.4	4.4	4.4	4.4	4.4	4.4
Units		600000	800000	10000000	10000000	500000	300000
Total contribution		2640000	3520000	44000000	44000000	2200000	1320000
Depreciation		1050000	1050000	1050000	1050000	1050000	1050000
PBT		1590000	2470000	42950000	42950000	1150000	270000
Tax @ 35%		556500	864500	15032500	15032500	402500	94500
PAT		1033500	1605500	27917500	27917500	747500	175500
Add: Depreciation		1050000	1050000	1050000	1050000	1050000	1050000
Cash flow		2083500	2655500	28967500	28967500	1797500	1225500
WC Changes	-360000	-120000	-5520000	0	5700000	120000	180000
Salvage value (549000-35%)							356850
Total cash flow	-6660000	1963500	-2864500	28967500	34667500	1917500	1762350
PVIF @ 10%	1	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645
Present value	-6660000	1785000	-2367355	21763711	23678369	1190617	994800.6	40385142

If WC is reduced to half

Statement showing WC requirement

Particulars	0	1	2	3	4	5	6
Sales units	0	600000	800000	10000000	10000000	500000	300000
Sales price per unit		6	6	6	6	6	6
Total sales		3600000	4800000	60000000	60000000	3000000	1800000
WC requirement	180000	240000	3000000	3000000	150000	90000	0
Increase In WC	180000	60000	2760000	0	-2850000	-60000	-90000
Change in cash	-180000	-60000	-2760000	0	2850000	60000	90000

Statement showing NPV

Particulars	0	1	2	3	4	5	6	NPV
Initial investment	-6300000
SPPU		6	6	6	6	6	6
VCUP		1.6	1.6	1.6	1.6	1.6	1.6
CPU		4.4	4.4	4.4	4.4	4.4	4.4
Units		600000	800000	10000000	10000000	500000	300000
Total contribution		2640000	3520000	44000000	44000000	2200000	1320000
Depreciation		1050000	1050000	1050000	1050000	1050000	1050000
PBT		1590000	2470000	42950000	42950000	1150000	270000
Tax @ 35%		556500	864500	15032500	15032500	402500	94500
PAT		1033500	1605500	27917500	27917500	747500	175500
Add: Depreciation		1050000	1050000	1050000	1050000	1050000	1050000
Cash flow		2083500	2655500	28967500	28967500	1797500	1225500
WC Changes	-180000	-60000	-2760000	0	2850000	60000	90000
Salvage value (549000-35%)							356850
Total cash flow	-6480000	2023500	-104500	28967500	31817500	1857500	1672350
PVIF @ 10%	1	0.9091	0.8264	0.7513	0.6830	0.6209	0.5645
Present value	-6480000	1839545	-86363.6	21763711	21731781	1153361	943998	40866033

Change in NPV = 40866033 - 40385142

=480891.3$