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 to a value of zero, 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 35%, and the required rate of return on the project is 11%. Use the MACRS depreciation schedule.

Sales (millions of traps) 0   1       2       3       4       5     6   Thereafter

                                      0 0.4   0.5    0,7   0,7   0,5   0.3

What is project NPV?

Answer 1

Solution:
Calculation of Project NPV
Particulars	Year (n)
0	1	2	3	4	5	6
Initial Investment
Investment in Equipment	-5700000
Operating Cashflows
Sales Revenue 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 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 ($5700000/6 years)		950000	950000	950000	950000	950000	950000
Profit Before Tax		1530000	2150000	3390000	3390000	2150000	910000
Less: Tax @35%		535500	752500	1186500	1186500	752500	318500
Profit After Tax		994500	1397500	2203500	2203500	1397500	591500
Addback Depreciation		950000	950000	950000	950000	950000	950000
Net Operating Cashflows		1944500	2347500	3153500	3153500	2347500	1541500
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	-320000	-80000	-160000	0	160000	160000	240000
Terminal Cashflow
Sale Value of Equipment							671000
Less: Tax @35%							234850
Net Sale value of the Equipment							436150
Total Cashflows	-6020000	1864500	2187500	3153500	3313500	2507500	2217650
Discounting Factor 11%	1	0.900901	0.811622	0.731191	0.658731	0.593451	0.534641
Discounted Cashflows	-6020000	1679730	1775424	2305812	2182705	1488079	1185646
Net Present Value	4597396.4