Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6.6 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 $643,000. 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 $1.90 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 12%. Use the MACRS depreciation schedule.

Year	Sales (Millions of Traps)
0	0
1	0.4
2	0.5
3	0.7
4	0.7
5	0.5
6	0.3
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.)

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

Question a:

Calculation of NPV of the Project using Straight line Depreciation

NPV of the Project with straight line Depreciaiton is $652,686.20

Question b:

Calculation of NPV of the Project using MACRS 5 Depreciation

NPV of the Project with MACRS 5 depreciation is $774,797.26

NPV of the Project with straight line Depreciaiton is $652,686.20

NPV increase = NPV of the Project with MACRS 5 depreciation - NPV of the Project with straight line Depreciaiton

= $774,797.26 - $652,686.20

=$122,111.06

Therefore, NPV increase if MACRS 5 year depreciation is used is $122,111.06