Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2715965 • Letter: B
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 $672,000. 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 $1.70 per trap and believes that the traps can be sold for $7 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 9%. Use the MACRS depreciation schedule.
Year: 0 1 2 3 4 5 6 Thereafter
Sales (millions of traps) 0 .5 .7 .8 .8 .7 .5 0
a. What is project NPV? (Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.) NPV $ million
b. By how much would NPV increase if the firm depreciated its investment using the 5-year MACRS schedule? (Do not round intermediate calculations. Enter your answer in whole dollars not in millions.) The NPV increases by $ .
Explanation / Answer
Better Mousetrap Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 MACRS table 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% Sales qty 500,000 700,000 800,000 800,000 700,000 500,000 Revenue 3,500,000 4,900,000 5,600,000 5,600,000 4,900,000 3,500,000 Cost 850,000 1,190,000 1,360,000 1,360,000 1,190,000 850,000 Net Contribution 2,650,000 3,710,000 4,240,000 4,240,000 3,710,000 2,650,000 Investment (6,300,000) Salvage 672,000 Net Contribution 2,650,000 3,710,000 4,240,000 4,240,000 3,710,000 2,650,000 Depreciation (1,050,000) (1,050,000) (1,050,000) (1,050,000) (1,050,000) (1,050,000) Taxable Income 1,600,000 2,660,000 3,190,000 3,190,000 2,660,000 2,272,000 Tax @35% 560,000 931,000 1,116,500 1,116,500 931,000 795,200 Post Tax income 1,040,000 1,729,000 2,073,500 2,073,500 1,729,000 1,476,800 Add back depreciation 1,050,000 1,050,000 1,050,000 1,050,000 1,050,000 1,050,000 Total Cash flow 2,090,000 2,779,000 3,123,500 3,123,500 2,779,000 2,526,800 Discount factor @9% 1 0.917 0.842 0.772 0.708 0.650 0.596 PV of cash flows (6,300,000) 1,917,431 2,339,029 2,411,915 2,212,766 1,806,159 1,506,648 NPV $ 5.8939 Million If depreciation is done by MACRS Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 MACRS table 20.00% 32.00% 19.20% 11.52% 11.52% 5.76% Sales qty 500,000 700,000 800,000 800,000 700,000 500,000 Revenue 3,500,000 4,900,000 5,600,000 5,600,000 4,900,000 3,500,000 Cost 850,000 1,190,000 1,360,000 1,360,000 1,190,000 850,000 Net Contribution 2,650,000 3,710,000 4,240,000 4,240,000 3,710,000 2,650,000 Investment (6,300,000) Salvage 672,000 Net Contribution 2,650,000 3,710,000 4,240,000 4,240,000 3,710,000 2,650,000 Depreciation (1,260,000) (2,016,000) (1,209,600) (725,760) (725,760) (362,880) Taxable Income 1,390,000 1,694,000 3,030,400 3,514,240 2,984,240 2,959,120 Tax @35% 486,500 592,900 1,060,640 1,229,984 1,044,484 1,035,692 Post Tax income 903,500 1,101,100 1,969,760 2,284,256 1,939,756 1,923,428 Add back depreciation 1,260,000 2,016,000 1,209,600 725,760 725,760 362,880 Total Cash flow 2,163,500 3,117,100 3,179,360 3,010,016 2,665,516 2,286,308 Discount factor @9% 1 0.917 0.842 0.772 0.708 0.650 0.596 PV of cash flows (6,300,000) 1,984,862 2,623,601 2,455,049 2,132,371 1,732,403 1,363,251 NPV $ 5.9915 Million If MACRS depreciation is used NPV increases by $97,588
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