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 $6.3 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 $583,000. 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 $1.10 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 firm’s tax bracket is 35%, and the required rate of return on the project is 12%. Use the MACRS depreciation schedule.

a. What is project NPV? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)

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.)

Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.6 0.8 0.9 0.9 0.8 0.6 0 Recovery Period Class 20 Year 3.75 7.22 6.68 6.18 5.71 5.28 4.89 4.52 4.46 4.46 4.46 4.46 4.46 4.46 4.46 4.46 4.46 2.23 Year(s) 3 Year 33.33 44.45 14.81 7.41 5 Year 20.00 32.00 19.20 11.52 11.52 5.76 7 Year 14.29 24.49 17.49 12.49 8.93 8.92 8.93 4.46 10 Year 10.00 18.00 14.40 11.52 9.22 7.37 6.55 6.55 6.56 6.55 3.28 15 Year 5.00 9.50 8.55 7.70 6.93 6.23 5.90 5.90 5.91 5.90 5.91 5.90 5.91 5.90 5.91 2.95 2 3 4 5 7 8 10 12 13 15 16 17-20 21 Notes: 1. Tax depreciation is lower in the first year because assets are assumed to be in service for 6 months. 2. Real property is depreciated straight-line over 27.5 years for residential property and 39 years for nonresidential property

Explanation / Answer

A) Statement showing NPV

WN1) WC Requirement

B) IF MACR Depreciation Method is Used

Statement showing Depreciation

Statement Showing NPV

Particulars 0 1 2 3 4 5 6 NPV Cost of Machine -6300000 SPPU 5 5 5 5 5 5 VCPU 1.1 1.1 1.1 1.1 1.1 1.1 CPU 3.9 3.9 3.9 3.9 3.9 3.9 No of units 600000 800000 900000 900000 800000 600000 Contribution 2340000 3120000 3510000 3510000 3120000 2340000 Depreciation -1050000 -1050000 -1050000 -1050000 -1050000 -1050000 PBT 1290000 2070000 2460000 2460000 2070000 1290000 Tax @ 35% 451500 724500 861000 861000 724500 451500 PAT 838500 1345500 1599000 1599000 1345500 838500 Add: Depreciation 1050000 1050000 1050000 1050000 1050000 1050000 Annual Cash flow 1888500 2395500 2649000 2649000 2395500 1888500 WC Requirement -300000 -100000 -50000 0 50000 100000 300000 Sales of Machine (583000-35%) 378950 Total cash flow -6600000 1788500 2345500 2649000 2699000 2495500 2567450 PVIF @ 12% 1 0.8929 0.7972 0.7118 0.6355 0.5674 0.5066 Present Value -6600000 1596875 1869818 1885506 1715263 1416014 1300750 3184226

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