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, but, in fact, it can be sold after 6 years for $668,000. The firm believes that working capital at each date must be maintained at a level of 15% 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 40%, 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	0.6	0.8	1.0	1.0	0.9	0.6	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?

Answer 1

In case of Better Inventory system Calculation of NPV is shown in sheet Below :

Increase in Projects NPV = 5934577.2 - 5786869.24

= 147707.96