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
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 $584,000. The firm believes that working capital at each date must be maintained at a level of 10% of next years forecast sales. The firm estimates production costs equal to $1.30 per trap and believes that the traps can be sold for $5 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 firms tax bracket is 40%, 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 | 0.7 | 0.8 | 0.8 | 0.7 | 0.4 | 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?
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