Question

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,580,000; the new one will cost, $1,897,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $375,000 after five years.

The old computer is being depreciated at a rate of $320,000 per year. It will be completely written off in three years. If we don’t replace it now, we will have to replace it in two years. We can sell it now for $513,000; in two years, it will probably be worth $147,000. The new machine will save us $326,000 per year in operating costs. The tax rate is 21 percent, and the discount rate is 8 percent.

a-1.	Calculate the EAC for the the old computer and the new computer. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
a-2.	What is the NPV of the decision to replace the computer now? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

How do you figure out a-2?

Answer 1

A-2
cost of new computer		-1897000
sale proceeds from sale of old computer		513000
tax credit on loss on sale of old computer		93870
net cash outflow		-1290130
cost of old computer		1580000
remaining book value of old computer	(320000*3)	960000
selling price of old computer		513000
loss on sale of old computer		447000
tax credit on loss on sale of old computer	(447000*21%)	93870
Year	Depreciation on new computer	depreciation on old computer	Incremental depreciation
1	379400	320000	59400
2	379400	320000	59400
3	379400	320000	59400
4	379400
5	379400
Year	0	1	2	3	4	5
net initial investment	-1290130
annual savings		326000	326000	326000	326000	326000
less incrementl depreciation		59400	59400	59400
operating savings		266600	266600	266600	326000	326000
less taxes -21%		55986	55986	55986	68460	68460
after tax savings		210614	210614	210614	257540	257540
add incremental depreciation		59400	59400	59400
add after tax sale proceeds from new computer = 375000*(1-.21)						296250
net cash flow	-1290130	270014	270014	270014	257540	553790
present value factor at 8% =1/(1+r)^n r =8%	1	0.925925926	0.857339	0.793832	0.73503	0.680583197
present value of net cash flow = net cash flow*PVF at 8%	-1290130	250012.963	231493.5	214345.8	189299.6	376900.1687
Net present value = sum of present value of net cash flow	-28077.98