Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $6 million. The equipment will be depreciated straight-line over 6 years but in fact, it can be sold after 6 years for $500,000. 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 $1.50 per trap and believes that the traps can be sold for $4 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 40%, and the required rate of return on the project is 12%.

Year: 0 1 2 3 4 5 6

Thereafter Sales (millions of traps) 0.00 0.50 0.60 1.00 1.00 0.60 0.20 0

a. What is project NPV?

b. By how much would NPV increase if the firm uses double-declining balance depreciation with a later switch to straight-line when remaining project life is only two years?

Answer 1