Question

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 $527,000. 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 $1.10 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 technologicalyl obsolete. The firm’s tax bracket is 35%, and the required rate of return on the project is 9%. Use the MACRS depreciation schedule. Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.5 0.7 0.9 0.9 0.6 0.4 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

NPV with straight line Method Depreciation = $3,204,902.46

NPV with MACRS 5 Method Depreciation = $3,288,549.41

Increase in NPV = NPV with MACRS 5 Method Depreciation - NPV with straight line Method Depreciation

= $3,288,549.41 - $3,204,902.46

= $83,646.95

Therefore, NPV increase is $83,646.95