1 answer

Better Mousetraps has developed a new trap. It can go into production for an initial investment...

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 $8 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 11%. Use the MACRS depreciation schedule.

Sales (millions of traps) 0   1       2       3       4       5     6   Thereafter

                                      0 0.4   0.5    0,7   0,7   0,5   0.3

What is project NPV?


Answers

Solution:
Calculation of Project NPV
Particulars Year (n)
0 1 2 3 4 5 6
Initial Investment
Investment in Equipment -5700000
Operating Cashflows
Sales Revenue
Y1: 400000 traps * $8 per trap
Y2: 500000 traps * $8 per trap
Y3: 700000 traps * $ 8 per trap
Y4: 700000 traps * $ 8 per trap
Y5: 500000 traps * $ 8 per trap
Y6: 300000 traps * $ 8 per trap
3200000 4000000 5600000 5600000 4000000 2400000
Less: Production Cost
Y1: 400000 traps * $1.8 per trap
Y2: 500000 traps * $1.8 per trap
Y3: 700000 traps * $1.8 per trap
Y4: 700000 traps * $1.8 per trap
Y5: 500000 traps * $1.8 per trap
Y6: 300000 traps * $1.8 per trap
720000 900000 1260000 1260000 900000 540000
Less: Depreciation
($5700000/6 years)
950000 950000 950000 950000 950000 950000
Profit Before Tax 1530000 2150000 3390000 3390000 2150000 910000
Less: Tax @35% 535500 752500 1186500 1186500 752500 318500
Profit After Tax 994500 1397500 2203500 2203500 1397500 591500
Addback Depreciation 950000 950000 950000 950000 950000 950000
Net Operating Cashflows 1944500 2347500 3153500 3153500 2347500 1541500
Investment in Working Capital
Investment in Working Capital -320000 -400000 -560000 -560000 -400000 -240000 0
Working Capital Already Invested 0 -320000 -400000 -560000 -560000 -400000 -240000
Net Investment in Working Capital -320000 -80000 -160000 0 160000 160000 240000
Terminal Cashflow
Sale Value of Equipment 671000
Less: Tax @35% 234850
Net Sale value of the Equipment 436150
Total Cashflows -6020000 1864500 2187500 3153500 3313500 2507500 2217650
Discounting Factor 11% 1 0.900901 0.811622 0.731191 0.658731 0.593451 0.534641
Discounted Cashflows -6020000 1679730 1775424 2305812 2182705 1488079 1185646
Net Present Value 4597396.4
.

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