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 $694,000. 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 $2.00 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 10%. Use the MACRS depreciation schedule.

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

$ In Millions Year 0 1 2 3 4 5 6 Sales units 0 0.4 0.5 0.6 0.6 0.8 0.5 Revenue 0 3.2 4 4.8 4.8 6.4 4 NWC 0.32 0.4 0.48 0.48 0.64 0.4 0 Cash flow NWC -0.32 -0.08 -0.08 0 -0.16 0.24 0.4 a Straightline Depreciation $ In Millions Year 0 1 2 3 4 5 6 Revenue 3.2 4 4.8 4.8 6.4 4 Expenses 0.8 1 1.2 1.2 1.6 1 Depreciation 0.9343 0.9343 0.9343 0.9343 0.9343 0.9343 Pretax Profit 1.4657 2.0657 2.6657 2.6657 3.8657 2.0657 Tax @ 35% 0.512983 0.722983 0.932983 0.932983 1.352983 0.722983 Net Income 0.9527 1.3427 1.7327 1.7327 2.5127 1.3427 OCF 1.8870 2.2770 2.6670 2.6670 3.4470 2.2770 Investment -6.3 0.4511 Cash flow NWC -0.32 -0.08 -0.08 0 -0.16 0.24 0.4 OCF 1.8870 2.2770 2.6670 2.6670 3.4470 2.2770 Total cash flow -6.6200 1.8070 2.1970 2.6670 2.5070 3.6870 3.1281 Discount factor @ 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 PV of cash flow -6.6200 1.6427 1.8157 2.0038 1.7123 2.2893 1.7657 NPV 4.6096 Depreciation (6.3-0.694)/6 b MACRS Depreciation $ In Millions Year 0 1 2 3 4 5 6 Revenue 3.2 4 4.8 4.8 6.4 4 Expenses 0.8 1 1.2 1.2 1.6 1 Depreciation $1.2600 $2.0160 $1.2096 $0.7257 $0.7257 $0.3629 Pretax Profit $1.1400 $0.9840 $2.3904 $2.8743 $4.0743 $2.6371 Tax $0.3990 $0.3444 $0.8366 $1.0060 $1.4260 $0.9230 Net Income $0.7410 $0.6396 $1.5538 $1.8683 $2.6483 $1.7141 OCF $2.0010 $2.6556 $2.7634 $2.5940 $3.3740 $2.0770 Investment -6.3 0.4511 Cash flow NWC -0.32 -0.08 -0.08 0 -0.16 0.24 0.4 OCF 2.001 2.6556 2.76336 2.594001 3.374001 2.077 Total cash flow -6.62 1.921 2.5756 2.76336 2.434001 3.614001 2.9281 Discount factor @ 10% 1.0000 0.9091 0.8264 0.7513 0.6830 0.6209 0.5645 PV of cash flow -6.62 1.746364 2.128595 2.076153 1.662455 2.24401 1.652836 NPV 4.890413 MACRS Depreciation Rate 0.2 $6.30 $1.2600 0.32 $6.30 $2.0160 0.192 $6.30 $1.2096 0.115193 $6.30 $0.7257 0.115193 $6.30 $0.7257 0.057596 $6.30 $0.3629 Change in NPV 4.8904-4.6096 0.2808 Increase in NPV $0.2808 millions

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