Better Mousetraps has developed a new trap. It can go into production for an ini
ID: 2765533 • 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 $510,000. 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 $1.40 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 30%, and the required rate of return on the project is 16%.
Year:
0
1
2
3
4
5
6
Thereafter
Sales (millions of traps)
0
0.5
0.6
1.1
1.1
0.6
0.2
0
What is project NPV? (Do not round intermediate calculations. Enter your answer in millions rounded to 4 decimal places.)
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.)
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 $510,000. 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 $1.40 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 30%, and the required rate of return on the project is 16%.
Explanation / Answer
a. The NPV of the project with straight line depreciation is as shown below:
b. The NPV with 5-year MACRS is as shown below:
NPV increases by $190,779.73
Year 0 1 2 3 4 5 6 Initial Investment -6000000 Sales 2000000 2400000 4400000 4400000 2400000 800000 Cost -700000 -840000 -1540000 -1540000 -840000 -280000 Depreciation -1000000 -1000000 -1000000 -1000000 -1000000 -1000000 Working Capital -200000 -240000 -440000 -440000 -240000 -80000 0 Profit before tax -6200000 60000 120000 1420000 1620000 480000 -480000 Tax at 30% 0 18000 36000 426000 486000 144000 0 Profit after tax -6200000 42000 84000 994000 1134000 336000 -480000 Add back depreciation 1000000 1000000 1000000 1000000 1000000 1000000 return of WC at the end 1640000 Salvage value after tax 357000 Operating Cash flow -6200000 1042000 1084000 1994000 2134000 1336000 2517000 NPV $ -370,904.81Related Questions
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