Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2739918 • Letter: B
Question
Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated straightline over 6 years to a value of zero, but in fact it can be sold after 6 years for $520,000. 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 $1.50 per trap and believes that the traps can be sold for $4 each. Sales forecasts are given in the following table. The project will come to an end in 5 years, when the trap becomes technologically obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 14%.
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? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations. Enter your answer in dollars rounded to 2 decimal places.)
0 1 2 3 4 56 Thereafter Year: Sales (millions of traps) 0 0.5 0.6 1.2 1.2 0.6 0.2 0Explanation / Answer
Answer
Year
0
1
2
3
4
5
6
Unit Sales
500
600
1,200
1,200
600
200
Revenues
2,000
2,400
4,800
4,800
2,400
800
Costs
750
900
1800
1800
900
300
Depreciation 6000,000/6
1,000
1,000
1,000
1,000
1,000
1,000
Pretax Profit (includes salvage in Year 6)
250
500
2,000
2,000
500
-500
Taxes at 35%
87.5
175
700
700
175
0
Profit after Tax
163
325
1,300
1,300
325
-500
Depreciation
1,000
1,000
1,000
1,000
1,000
1,000
Cash Flow from Operations
1,163
1,325
2,300
2,300
1,325
500
Change in Working Capital
-200
-40
-240
0
240
160
80
Capital Investment
-6,200
338
Net Cash Flows
-6,400
1,123
1,085
2,300
2,540
1,485
580
Discount Factor @ 14%
1
0.877193
0.769468
0.674972
0.59208
0.519369
0.455587
Present Value
-6,400
985
835
1,552
1,504
771
264
NPV
-489
2
If firm uses MARCS year Method of Depreciation then NPV will bw as follow
Year
0
1
2
3
4
5
6
Unit Sales
500
600
1,200
1,200
600
200
Revenues
2,000
2,400
4,800
4,800
2,400
800
Costs
750
900
1800
1800
900
300
Depreciation 6000,000/6
1,200
1,920
1,152
691
691
346
Pretax Profit (includes salvage in Year 6)
50
-420
1,848
2,309
809
154
Taxes at 35%
17.5
-147
646.8
808.08
283.08
0
Profit after Tax
33
-273
1,201
1,501
526
154
Depreciation
1,200
1,920
1,152
691
691
346
Cash Flow from Operations
1,233
1,647
2,353
2,192
1,217
500
Change in Working Capital
-200
-40
-240
0
240
160
80
Capital Investment
-6,200
338
Net Cash Flows
-6,400
1,193
1,407
2,353
2,432
1,377
580
Discount Factor @ 14%
1
0.877193
0.769468
0.674972
0.59208
0.519369
0.455587
Present Value
-6,400
1,046
1,083
1,588
1,440
715
264
NPV
-264
Year
0
1
2
3
4
5
6
Unit Sales
500
600
1,200
1,200
600
200
Revenues
2,000
2,400
4,800
4,800
2,400
800
Costs
750
900
1800
1800
900
300
Depreciation 6000,000/6
1,000
1,000
1,000
1,000
1,000
1,000
Pretax Profit (includes salvage in Year 6)
250
500
2,000
2,000
500
-500
Taxes at 35%
87.5
175
700
700
175
0
Profit after Tax
163
325
1,300
1,300
325
-500
Depreciation
1,000
1,000
1,000
1,000
1,000
1,000
Cash Flow from Operations
1,163
1,325
2,300
2,300
1,325
500
Change in Working Capital
-200
-40
-240
0
240
160
80
Capital Investment
-6,200
338
Net Cash Flows
-6,400
1,123
1,085
2,300
2,540
1,485
580
Discount Factor @ 14%
1
0.877193
0.769468
0.674972
0.59208
0.519369
0.455587
Present Value
-6,400
985
835
1,552
1,504
771
264
NPV
-489
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