Question

I need an to check my answer with 4 decimal places:

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.4 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 $682,000. 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 $1.30 per trap and believes that the traps can be sold for $5 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 8%.

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.)

Use the MACRS depreciation schedule.

Year:	0	1	2	3	4	5	6	Thereafter
Sales (millions of traps)	0	0.5	0.7	0.8	0.8	0.7	0.5	0

Answer 1

Answer a.

Calculation of Net present value-

Year	Initial Investment	Sales	Working capital	Variable cost	Depreciation	Sale value of equipment	Profit before tax	Tax @35%	Profit after tax	Add back depreciation	Cash flow after tax	PV factor @8%	PV of cash flow after tax
0	-5400000		-250000								-5650000	1	-5650000
1		2500000	-350000	-650000	-900000		600000	210000	390000	900000	1290000	0.925925926	1194444.4444
2		3500000	-400000	-910000	-900000		1290000	451500	838500	900000	1738500	0.85733882	1490483.5391
3		4000000	-400000	-1040000	-900000		1660000	581000	1079000	900000	1979000	0.793832241	1570994.0050
4		4000000	-350000	-1040000	-900000		1710000	598500	1111500	900000	2011500	0.735029853	1478512.5489
5		3500000	-250000	-910000	-900000		1440000	504000	936000	900000	1836000	0.680583197	1249550.7498
6		2500000	0	-650000	-900000	682000	1632000	571200	1060800	900000	1960800	0.630169627	1235636.6044
Net present value													1333985.287

Note - Initial cost of investment has been added in table therefore NPV is directly calculated from table.

Answer b.

Calculation of Net present value when depreciation is calculated on MACRS basis-

Calculation of depreciation as per MACRS method-

Year	Rate	Depreciation
1	20	1080000
2	32	1728000
3	19.2	1036800
4	11.52	622080
5	11.52	622080
6	5.76	311040

Rest calculation will be the same as below-

Year	Initial Investment	Sales	Working capital	Variable cost	Depreciation	Sale value of equipment	Profit before tax	Tax @35%	Profit after tax	Add back depreciation	Cash flow after tax	PV factor @8%	PV of cash flow after tax
0	-5400000		-250000								-5650000	1	-5650000
1		2500000	-350000	-650000	-1080000		420000	147000	273000	1080000	1353000	0.925925926	1252777.7778
2		3500000	-400000	-910000	-1728000		462000	161700	300300	1728000	2028300	0.85733882	1738940.3292
3		4000000	-400000	-1040000	-1036800		1523200	533120	990080	1036800	2026880	0.793832241	1609002.6927
4		4000000	-350000	-1040000	-622080		1987920	695772	1292148	622080	1914228	0.735029853	1407014.7251
5		3500000	-250000	-910000	-622080		1717920	601272	1116648	622080	1738728	0.680583197	1183349.0610
6		2500000	0	-650000	-311040	682000	2220960	777336	1443624	311040	1754664	0.630169627	1105735.9582
Net present value													1541084.586