Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $5.7 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 $671,000. 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 $1.80 per trap and believes that the traps can be sold for $7 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%. Use the MACRS depreciation schedule. Year: 0 1 2 3 4 5 6 Thereafter Sales (millions of traps) 0 0.4 0.6 0.7 0.7 0.5 0.3 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

a)		0	1	2	3	4	5	6
	Sales in units		400000	600000	700000	700000	500000	300000
	Sales revenue [$7/Unit]		$    28,00,000	$ 42,00,000	$ 49,00,000	$ 49,00,000	$   35,00,000	$ 21,00,000
	Cost of production [$1.80/Unit]		$      7,20,000	$ 10,80,000	$ 12,60,000	$ 12,60,000	$     9,00,000	$     5,40,000
	Depreciation [Straight line]		$      9,50,000	$    9,50,000	$    9,50,000	$    9,50,000	$     9,50,000	$     9,50,000
	NOI		$    11,30,000	$ 21,70,000	$ 26,90,000	$ 26,90,000	$   16,50,000	$     6,10,000
	Tax at 35%		$      3,95,500	$    7,59,500	$    9,41,500	$    9,41,500	$     5,77,500	$     2,13,500
	NOPAT		$      7,34,500	$ 14,10,500	$ 17,48,500	$ 17,48,500	$   10,72,500	$     3,96,500
	Add: Depreciation		$      9,50,000	$    9,50,000	$    9,50,000	$    9,50,000	$     9,50,000	$     9,50,000
	OCF		$    16,84,500	$ 23,60,500	$ 26,98,500	$ 26,98,500	$   20,22,500	$ 13,46,500
	Capital expenditure	$      57,00,000						$   -4,36,150	[671000*(1-35%)]
	Change in NWC	$         2,80,000	$      1,40,000	$       70,000	$                 -	$   -1,40,000	$    -1,40,000	$   -2,10,000
	Project cash flows	$     -59,80,000	$    15,44,500	$ 22,90,500	$ 26,98,500	$ 28,38,500	$   21,62,500	$ 19,92,650
	PVIF at 8% [PVIF = 1/1.08^t]	1	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017
	PV at 8%	$     -59,80,000	$    14,30,093	$ 19,63,735	$ 21,42,156	$ 20,86,382	$   14,71,761	$ 12,55,708
	NPV	$      43,69,834
b)		0	1	2	3	4	5	6
	Sales in units		400000	600000	700000	700000	500000	300000
	Sales revenue [$7/Unit]		$    28,00,000	$ 42,00,000	$ 49,00,000	$ 49,00,000	$   35,00,000	$ 21,00,000
	Cost of production [$1.80/Unit]		$      7,20,000	$ 10,80,000	$ 12,60,000	$ 12,60,000	$     9,00,000	$     5,40,000
	Depreciation [MACRS]		$    11,40,000	$ 18,24,000	$ 10,94,400	$    6,56,640	$     6,56,640	$     3,28,320	$             57,00,000
	NOI		$      9,40,000	$ 12,96,000	$ 25,45,600	$ 29,83,360	$   19,43,360	$ 12,31,680
	Tax at 35%		$      3,29,000	$    4,53,600	$    8,90,960	$ 10,44,176	$     6,80,176	$     4,31,088
	NOPAT		$      6,11,000	$    8,42,400	$ 16,54,640	$ 19,39,184	$   12,63,184	$     8,00,592
	Add: Depreciation		$    11,40,000	$ 18,24,000	$ 10,94,400	$    6,56,640	$     6,56,640	$     3,28,320
	OCF		$    17,51,000	$ 26,66,400	$ 27,49,040	$ 25,95,824	$   19,19,824	$ 11,28,912
	Capital expenditure	$      57,00,000						$   -4,36,150
	Change in NWC	$         2,80,000	$      1,40,000	$       70,000	$                 -	$   -1,40,000	$    -1,40,000	$   -2,10,000
	Project cash flows	$     -59,80,000	$    16,11,000	$ 25,96,400	$ 27,49,040	$ 27,35,824	$   20,59,824	$ 17,75,062
	PVIF at 8% [PVIF = 1/1.08^t]	1	0.92593	0.85734	0.79383	0.73503	0.68058	0.63017
	PV at 8%	$     -59,80,000	$    14,91,667	$ 22,25,995	$ 21,82,277	$ 20,10,912	$   14,01,882	$ 11,18,590
	NPV	$      44,51,322
	Increase in NPV	$            81,487