Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2716165 • Letter: B
Question
Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.7 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 $671,000. 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 $8 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 11%. Use the MACRS depreciation schedule.
Year: 0 1 2 3 4 5 6 Thereafter
Sales (millions of traps) 0 .4 .5 .7 .7 .5 .3 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
Answer :
Determination of Cash Flow after Tax
Present value of salvage = 0.671*0.8079 =0.5421
Total Present Value of cash inflow = 2.0813+1.8757+2.2734+2.0495+1.3698+0.8079+0.5421
= 10.9997
Intitial out lay = 5.7100
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NPV 5.2897
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*Depreication : (5.7-.671)/6 = 0.84
Answer B
Determination of Cash Flow after Tax
Present value of salvage = 0.671*0.8079 =0.5421
Total Present Value of cash inflow = 2.175+2.1545+2.3421+2.0104+1.3312+0.7083+0.5421
= 11.2636
Intitial out lay = 5.7100
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NPV 5.5536
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Convert in dollar = 5.5536*1000000 = 5553600
NPV in dollar = 5553600
Previous NPV = 5.2897*1000000 = 5289700
NPV Increase due to MACRS chart = 5553600-5289700
= $ 263900
Particulars/years 1 2 3 4 5 6 Sales in unit 0.5 0.5 0.7 0.7 0.5 0.3 Sales Value @ 8 4.00 4.00 5.60 5.60 4.00 2.40 Production cost @ 1.80 0.90 0.90 1.26 1.26 0.90 0.54 Contribution 3.10 3.10 4.34 4.34 3.10 1.86 Deperication* 0.84 0.84 0.84 0.84 0.84 0.84 Profit 2.26 2.26 3.50 3.50 2.26 1.02 Tax @35% 0.79 0.79 1.23 1.23 0.79 0.35 Profit After tax 1.47 1.47 2.27 2.27 1.47 0.67 Cash flow = dep + profit 2.31 2.31 3.11 3.11 2.31 1.51 PV Factor 0.901 0.812 0.731 0.659 0.593 0.535 Present Value 2.0813 1.8757 2.2734 2.0495 1.3698 0.8079Related Questions
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