Better Mousetraps has developed a new trap.

If this new product is introduced, the company estimtaes that 1 million unit
next 3 years. Unit sales are expected to decline to 60% and 30% of the peak value in years 4 and 5, respectively. After yea
become obsolete.
It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated over 6 yea
but in fact it can be sold at the end of 5 years for $500,000. The firm has spent $600,000 for the development of the new tr
will be depreciated over 5 years.

The managers estimate that working capital requirement will be 10% of sales. Production cost will be $1.50 per trap, and t
sold for $4 each. Estimated sales volumes for the next 5 years are given below. General expenses are expected to increas
annually with this product.

The firm decided to borrow $4 million for equipment purchase, which will be paid at the end of the 5th year. The loan has
with annual interest payments. Discount rate to be used is 12%, and the firm's tax rate is 35%. What is the project NPV?

Year 0 1 2 3
Sales (million units) - 1.0 1.0 0.2

Unit Cost $1.40 Tax Rate 35%

Price 4.00 Discount Rate 12%

Cash Flows from Investments

Equipment Initial Cost 6,000

Lifetime 6
Sale price 500 at year 5

Year 0 1 2 3
Book Value BOY - 6,000 5,000 4,000
Depreciation 1,000 1,000 1,000
Book Value EOY 6,000 5,000 4,000 3,000

Depreciation tax shield - 350 350 350

investment (6,000)
Salvage value 675
After-tax cash flows (6,000) 350 350 350

R&D Costs Initial Cost 600

Lifetime 5

Year 0 1 2 3
Book Value BOY - 600 480 360
Depreciation 120 120 120
Book Value EOY 600 480 360 240
it is already paid so after tax cash flow is 0
After-tax cash flows

Loan Schedule Amount 4,000

Maturity 5
Interest Rate 8%

Year 0 1 2 3
 Loan EOY 4,000 4,000 4,000 4,000
Principal Payments - - -
Interest Payments 320 320 320

Cash Flows from Operations

Year 0 1 2 3
Sales 4,000.0 4,000.0 800.0
COGS 1,400.0 1,400.0 280.0
Gross Profit 2,600.0 2,600.0 520.0
General Expenses (100) (100) (100)
Depreciation (1,000) (1,000) (1,000)
EBIT 1,500 1,500 (580)
Interest
Earnings BT 1,500 1,500 (580)
Taxes (525) (525) 203
Net Income 975 975 (377)

After-tax cash flows 1,975 1,975 623

Cash Flows from Changes in NWC

Year 0 1 2 3
Sales 4,000 4,000 800
Required NWC 400 400 80
Change in NWC (400) - 320 32

Project Cash Flows

Year 0 1 2 3
Cash Flows (6,400) 2,325 2,645 1,005

NPV
IRR
e company estimtaes that 1 million units will be sold over the
n years 4 and 5, respectively. After year 5, the product will

quipment will be depreciated over 6 years to a value of zero,

0,000 for the development of the new trap, and this amount

uction cost will be $1.50 per trap, and the traps could be
neral expenses are expected to increase by $100,000

the end of the 5th year. The loan has an interest rate of 8%
ate is 35%. What is the project NPV?

4 5 6
0.1 0.3 -

NWC Req. 10%

General Expenses 100

4 5 6
3,000 2,000
1,000 1,000
2,000 1,000

350 350

350 1,025

4 5
240 120
120 120
120 -

4 5
 4,000 -
- 4,000
320 320

4 5
480.0 1,200.0 -
168.0 420.0 -
312.0 780.0 -
(100) (100)
(1,000) (1,000)
(788) (320)

(788) (320)
276 112
(512) (208)

488 792

4 5
480 1,200 - we invest 400
48 120
(72) 120

4 5
766 1,937
Assumptions:
Margin of Error
Sales Price $4.00 10%
Peak Sales Level
(million units) 1.0 10%
Annual Sales as % of Peak Level 1 2 3 4 5
100% 100% 100% 60% 30%

Unit Cost $1.40 15%

Equipment Salvage
Value at year 5 500 20%
Low High
NWC Requirement 10% 8% 15%
 6
0%
SENSITIVITY ANALYSIS
Base Low High
Sales Price $4.00 $3.60 $4.40 Note about setting up this sheet
NPV -
IRR 0.0%

Peak Sales 1.0 0.9 1.1

NPV -
IRR 0.0%

Unit Cost 1.4 1.2 1.6

NPV -
IRR 0.0%

Salvage Value 500 400 600

NPV -
IRR 0.0%

NWC Requirement 10% 8% 15%

NPV -
IRR 0.0%

BREAK-EVEN ANALYSIS
Fixed Costs 1,100
Gross-Margin $2.60

Accounting
Break-Even 0.42 million units

NPV Break-Even - million units

Gross Fixed Net

NPV Profit Costs Income
- 312 1,100 (377)
0.05 0.20 - 312 1,100 (377)
0.25 - 312 1,100 (377)
0.30 - 312 1,100 (377)
0.35 - 312 1,100 (377)
0.40 - 312 1,100 (377)
0.45 - 312 1,100 (377)
0.50 - 312 1,100 (377)
0.55 - 312 1,100 (377)
0.60 - 312 1,100 (377)
0.65 - 312 1,100 (377)
0.70 - 312 1,100 (377)
0.75 - 312 1,100 (377)
0.80 - 312 1,100 (377)
0.85 - 312 1,100 (377)
0.90 - 312 1,100 (377)
0.95 - 312 1,100 (377)
1.00 - 312 1,100 (377)
1.05 - 312 1,100 (377)
1.10 - 312 1,100 (377)
1.15 - 312 1,100 (377)
1.20 - 312 1,100 (377)
1.25 - 312 1,100 (377)
1.30 - 312 1,100 (377)
1.35 - 312 1,100 (377)
1.40 - 312 1,100 (377)
 3,000

2,000

1,000

- 1,000

- 2,000

- 3,000
0.2 0.4 0.6 0.8 1.0 1.2 1.4