Question

Better Mousetraps has developed a new trap. It can go into production for an initial investment in equipment of $20.4 million. The equipment will be depreciated straight line over 6 years, 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 20% of next year’s forecast sales. The firm estimates production costs equal to $7.50 per trap and believes that the traps can be sold for $16 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	0.62	0.79	1.00	1.00	0.48	0.20	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 3 decimal places.)

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? (Do not round intermediate calculations. Enter your answer in millions rounded to 3 decimal places.)

Answer 1

a
Sales computation
Year	0	1	2	3	4	5	6
Sales (units in Mn)	0	0.62	0.79	1	1	0.48	0.2
Price / unit	16	16	16	16	16	16	16
Sales (Mn)	-	9.9200	12.6400	16.0000	16.0000	7.6800	3.2000
Production cost computation
Year	0	1	2	3	4	5	6
Sales (units in Mn)	0	0.62	0.79	1	1	0.48	0.2
production cost / unit	(7.50)	(7.50)	(7.50)	(7.50)	(7.50)	(7.50)	(7.50)
Production costs (Mn)	-	(4.6500)	(5.9250)	(7.5000)	(7.5000)	(3.6000)	(1.5000)
Working capital computation
Year	0	1	2	3	4	5	6
Sales (units in Mn)	0	0.62	0.79	1	1	0.48	0.2
Price / unit	16	16	16	16	16	16	16
Sales forecast (in Mn)	0	9.92	12.64	16	16	7.68	3.2
Working capital requirement (20% of next year sales forecast)	(1.9840)	(2.5280)	(3.2000)	(3.2000)	(1.5360)	(0.6400)	-
Infusion of working capital or removal	(1.9840)	(0.5440)	(0.6720)	-	1.6640	0.8960	0.6400
Depreciation computation
Year	0	1	2	3	4	5	6
Investment	20.4
Depreciation (Investment / 6 years)		(3.4000)	(3.4000)	(3.4000)	(3.4000)	(3.4000)	(3.4000)
Cashflow table
Year	0	1	2	3	4	5	6
Initial cashflows
Investment (in Mn)	(20.40)
Intermediate cashflows (in Mn)
Sales	-	9.9200	12.6400	16.0000	16.0000	7.6800	3.2000
Production costs	-	(4.6500)	(5.9250)	(7.5000)	(7.5000)	(3.6000)	(1.5000)
Depreciation	-	(3.4000)	(3.4000)	(3.4000)	(3.4000)	(3.4000)	(3.4000)
Earnings before tax	-	1.8700	3.3150	5.1000	5.1000	0.6800	(1.7000)
Tax @ 40%	-	(0.7480)	(1.3260)	(2.0400)	(2.0400)	(0.2720)	0.6800
Earnings after tax	-	1.1220	1.9890	3.0600	3.0600	0.4080	(1.0200)
Add: Depreciation	-	3.4000	3.4000	3.4000	3.4000	3.4000	3.4000
Infusion of working capital or removal	(1.9840)	(0.5440)	(0.6720)	-	1.6640	0.8960	0.6400
Cashflows	(1.9840)	3.9780	4.7170	6.4600	8.1240	4.7040	3.0200
Terminal Cashflows
Salvage value (in Mn)							0.6430
Total Cashflows	(22.3840)	3.9780	4.7170	6.4600	8.1240	4.7040	3.6630
PV factor @ 12% ---> 1/(1+12%)^n; where n refers to period	1.0000	0.8929	0.7972	0.7118	0.6355	0.5674	0.5066
PV of cashflows (cashflows X PV factor)	(22.3840)	3.5518	3.7604	4.5981	5.1629	2.6692	1.8558
Net Present Value (in Mn)	(0.786)

b
Depreciation computation
Year	0	1	2	3	4	5	6
Investment	20.4
Depreciation (Investment / 6 years) ---> Double declining balance method for 4 years and straight line for balance 2 years		(6.8000)	(6.8000)	(6.8000)
Cashflow table
Year	0	1	2	3	4	5	6
Initial cashflows
Investment (in Mn)	(20.40)
Intermediate cashflows (in Mn)
Sales	-	9.9200	12.6400	16.0000	16.0000	7.6800	3.2000
Production costs	-	(4.6500)	(5.9250)	(7.5000)	(7.5000)	(3.6000)	(1.5000)
Depreciation	-	(6.8000)	(6.8000)	(6.8000)	-	-	-
Earnings before tax	-	(1.5300)	(0.0850)	1.7000	8.5000	4.0800	1.7000
Tax @ 40%	-	0.6120	0.0340	(0.6800)	(3.4000)	(1.6320)	(0.6800)
Earnings after tax	-	(0.9180)	(0.0510)	1.0200	5.1000	2.4480	1.0200
Add: Depreciation	-	6.8000	6.8000	6.8000	-	-	-
Infusion of working capital or removal	(1.9840)	(0.5440)	(0.6720)	-	1.6640	0.8960	0.6400
Cashflows	(1.9840)	5.3380	6.0770	7.8200	6.7640	3.3440	1.6600
Terminal Cashflows
Salvage value (in Mn)							0.6430
Total Cashflows	(22.3840)	5.3380	6.0770	7.8200	6.7640	3.3440	2.3030
PV factor @ 12% ---> 1/(1+12%)^n; where n refers to period	1.0000	0.8929	0.7972	0.7118	0.6355	0.5674	0.5066
PV of cashflows (cashflows X PV factor)	(22.3840)	4.7661	4.8445	5.5661	4.2986	1.8975	1.1668
Net Present Value (in Mn)	0.156