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 $668,000. The firm believes that working capital at each date must be maintained at a level of 15% of next year’s forecast sales. The firm estimates production costs equal to $1.60 per trap and believes that the traps can be sold for $6 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 9%. Use the MACRS depreciation schedule.

Year: Sales (millions of traps)

Year 0 ---------------------0

Year 1----------------------0.6

Year 2----------------------0.8

Year 3----------------------1.0

Year 4----------------------1.0

Year 5----------------------0.9

Year 6----------------------0.6

Thereafter-----------------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.)

NPV-----------$

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.)

The NPV increases by $

Answer 1

year	0	1	2	3	4	5	6
Initial investment	-5.4
sales revenue		3.6	4.8	6	6	5.4	3.6
less production cost =		0.96	12.8	1.6	1.6	1.44	0.96
annual depreciation = 5.4/6		0.9	0.9	0.9	0.9	0.9	0.9
operating profit		1.74	-8.9	3.5	3.5	3.06	1.74
less taxes-35%		0.609	-3.115	1.225	1.225	1.071	0.609
after tax profit		1.131	-5.785	2.275	2.275	1.989	1.131
add depreciation		0.9	0.9	0.9	0.9	0.9	0.9
after tax sale proceeds =.668*(1-.35)							0.4342
cash flow from working capital	-0.54	-0.18	-0.18	0	0.09	0.27	0.54
net operating cash flow	-5.94	1.851	-5.065	3.175	3.265	3.159	3.0052
present value factor at 9% = 1/(1+r)^n r =9%	1	0.917431193	0.841679993	0.77218348	0.70842521	0.64993139	0.59626733
present value of net operating cash flow = net operating cash flow*pvf	-5.94	1.698165138	-4.263109166	2.451682549	2.31300831	2.05313325	1.79190257
1-net present value = sum of present valur of cash flow	0.1048
investment in working capital-15% of next year forecasted sale
year	0	1	2	3	4	5	6
investment in working capital-15% of next year forecasted sale	0.54	0.72	0.9	0.9	0.81	0.54	0
cash flow from working capital	-0.54	-0.18	-0.18	0	0.09	0.27	0.54
2-
year	0	1	2	3	4	5	6
Initial investment	-5.4
sales revenue		3.6	4.8	6	6	5.4	3.6
less production cost =		0.96	12.8	1.6	1.6	1.44	0.96
annual depreciation = 5.4/6		1.08	1.728	1.0368	0.62208	0.62208	0.31104
operating profit		1.56	-9.728	3.3632	3.77792	3.33792	2.32896
less taxes-35%		0.546	-3.4048	1.17712	1.322272	1.168272	0.815136
after tax profit		1.014	-6.3232	2.18608	2.455648	2.169648	1.513824
add depreciation		1.08	1.728	1.0368	0.62208	0.62208	0.31104
after tax sale proceeds =.668*(1-.35)							0.4342
cash flow from working capital	-0.54	-0.18	-0.18	0	0.09	0.27	0.54
net operating cash flow	-5.94	1.914	-4.7752	3.22288	3.167728	3.061728	2.799064
present value factor at 9% = 1/(1+r)^n r =9%	1	0.917431193	0.841679993	0.77218348	0.70842521	0.64993139	0.59626733
present value of net operating cash flow = net operating cash flow*pvf	-5.94	1.755963303	-4.019190304	2.488654694	2.24409838	1.98991312	1.66899041
net present value = sum of present valur of cash flow	0.1884
investment in working capital-15% of next year forecasted sale
year	0	1	2	3	4	5	6
investment in working capital-15% of next year forecasted sale	0.54	0.72	0.9	0.9	0.81	0.54	0
cash flow from working capital	-0.54	-0.18	-0.18	0	0.09	0.27	0.54
year	1	2	3	4	5	6
cost of machine	5.4	5.4	5.4	5.4	5.4	5.4
macrs dep rate	20%	32%	19.20%	11.52%	11.52%	5.76%
annual depreciation	1.08	1.728	1.0368	0.62208	0.62208	0.31104
increase in NPV if machine is depreciated by Macrs depreciation method	.1884-.1048	0.0836
increase in NPV if machine is depreciated by Macrs depreciation method in dollars = .0836*1000000	83600