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 $695,000. 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 $7 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 0.6 0.8 0.9 0.9 0.5 0.2 0 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.)

Explanation / Answer

With straight line depreciation, annual depreciation = Cost / No. of years = 6.3 / 6 = 1.05

Cash Flows = Investment + NWC + Net Income + Depreciation + After-tax Salvage

NPV can be calculated using the same function in excel with 11% discount rate.

With MACRS, annual depreciation = MACRS % x Investment

NPV will increase by $110,791 (5.002165 - 4.891374)

Year 0 1 2 3 4 5 6 Units 0.6 0.8 0.9 0.9 0.5 0.2 Investment -6.3 NWC -0.42 -0.14 -0.07 0 0.28 0.21 0.14 Salvage 0.695 Sales 4.2 5.6 6.3 6.3 3.5 1.4 Costs 1.08 1.44 1.62 1.62 0.9 0.36 Depreciation 1.05 1.05 1.05 1.05 1.05 1.05 EBT 2.07 3.11 3.63 3.63 1.55 -0.01 Taxes (35%) 0.7245 1.0885 1.2705 1.2705 0.5425 -0.0035 Net Income 1.3455 2.0215 2.3595 2.3595 1.0075 -0.0065 Cash Flows -6.72 2.2555 3.0015 3.4095 3.6895 2.2675 1.63525 NPV $4.891374

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.