Better Mousetraps has developed a new trap. It can go into production for an ini

Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6.0 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 $511,000. 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 $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 8%. Use the MACRS depreciation schedule. Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 .4 .5 .6 .6 .5 .4 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

Thus, the NPV of the project is = $3876837.71 = 3.8768 million

For Years 1 to 5

Cash Flow = (Sales - Production Cost - Depreciation) * (1 - Tax Rate) + Depreciation - Working Capital

For Year 6

After Tax Slavage Value = Salvage Value - (Salvage Value - Book Value) * Tax Rate

                                          = 511000 - (511000 - 0) * 0.35 = 511000 - 178850 = $332,150

Cash Flow = (Sales - Production Cost - Depreciation) * (1 - Tax Rate) + Depreciation - Working Capital + After Tax Salvage Value

Using 5 year MACRS schedule

The NPV will become $3962613.99 = $3.9626 million

Increase in NPV = 3962613.99 - 3876837.71 = $85776.28

Year Initial Investment Working Capital Sales (Traps) Sales Production Cost Depreciation Salvage Value After Tax Salvage Value Cash Flow Discounted Cash Flow 0 6000000 280000 0 0 0 0 0 0 -6280000 -6280000.00 1 0 350000 400000 2800000 720000 1000000 0 0 1352000 1251851.85 2 0 420000 500000 3500000 900000 1000000 0 0 1620000 1388888.89 3 0 420000 600000 4200000 1080000 1000000 0 0 1958000 1554323.53 4 0 560000 600000 4200000 1080000 1000000 0 0 1818000 1336284.27 5 0 280000 800000 5600000 1440000 1000000 0 0 2774000 1887937.79 6 0 -2310000 400000 2800000 720000 1000000 511000 332150 4344150 2737551.38 NET PRESENT VALUE 3876837.71

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