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. Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.4 0.5 0.6 0.6 0.8 0.5 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.)

Answer 1

Part (a) Project NPV = $ 4.7860 million

Straight line depreciation case:

Please see the table below. Please be guided by the second column titled “Linkage” to understand the mathematics. The last row highlighted in yellow is your answer. Figures in parenthesis, if any, mean negative values. All financials are in $ mn. Adjacent cells in blue contain the formula in excel I have used to get the final output.

Part (b)

NPV increase =  4,890,443.51 - 4,785,962.60 = $ 104,481