Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2715407 • Letter: B
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 depreciated straight line over 6 years to a value of zero, 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 year’s 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 firm’s tax bracket is 35%, and the required rate of return on the project is 10%. Use the MACRS depreciation schedule.
Year: 0 1 2 3 4 5 6 Thereafter
Sales (millions of traps) 0 .6 .7 .8 .8 .7 .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
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 600,000 700,000 800,000 800,000 700,000 400,000 Revenue 3,000,000 3,500,000 4,000,000 4,000,000 3,500,000 2,000,000 Cost 780,000 910,000 1,040,000 1,040,000 910,000 520,000 Net Contribution 2,220,000 2,590,000 2,960,000 2,960,000 2,590,000 1,480,000 Investment (5,400,000) Salvage 584,000 Net Contribution 2,220,000 2,590,000 2,960,000 2,960,000 2,590,000 1,480,000 Depreciation (900,000) (900,000) (900,000) (900,000) (900,000) (900,000) Taxable Income 1,320,000 1,690,000 2,060,000 2,060,000 1,690,000 1,164,000 Tax @35% 462,000 591,500 721,000 721,000 591,500 407,400 Post Tax income 858,000 1,098,500 1,339,000 1,339,000 1,098,500 756,600 Add back depreciation 900,000 900,000 900,000 900,000 900,000 900,000 Total Cash flow 1,758,000 1,998,500 2,239,000 2,239,000 1,998,500 1,656,600 Discount factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 PV of cash flows (5,400,000) 1,598,182 1,651,653 1,682,194 1,529,267 1,240,911 935,108 NPV $ 3.2373 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 600,000 700,000 800,000 800,000 700,000 400,000 Revenue 3,000,000 3,500,000 4,000,000 4,000,000 3,500,000 2,000,000 Cost 780,000 910,000 1,040,000 1,040,000 910,000 520,000 Net Contribution 2,220,000 2,590,000 2,960,000 2,960,000 2,590,000 1,480,000 Investment (5,400,000) Salvage 584,000 Net Contribution 2,220,000 2,590,000 2,960,000 2,960,000 2,590,000 1,480,000 Depreciation (1,080,000) (1,728,000) (1,036,800) (622,080) (622,080) (311,040) Taxable Income 1,140,000 862,000 1,923,200 2,337,920 1,967,920 1,752,960 Tax @35% 399,000 301,700 673,120 818,272 688,772 613,536 Post Tax income 741,000 560,300 1,250,080 1,519,648 1,279,148 1,139,424 Add back depreciation 1,080,000 1,728,000 1,036,800 622,080 622,080 311,040 Total Cash flow 1,821,000 2,288,300 2,286,880 2,141,728 1,901,228 1,450,464 Discount factor @10% 1 0.909 0.826 0.751 0.683 0.621 0.564 PV of cash flows (5,400,000) 1,655,455 1,891,157 1,718,167 1,462,829 1,180,513 818,749 NPV $ 3.3269 Million If MACRS depreciation is used NPV increases by $89,555
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