Question

In: Finance

Suppose we are thinking about replacing an old computer with a new one. The old one...

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,390,000; the new one will cost, $1,650,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $390,000 after five years. The old computer is being depreciated at a rate of $278,000 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 $510,000; in two years, it will probably be worth $129,000. The new machine will save us $299,000 per year in operating costs. The tax rate is 38 percent, and the discount rate is 12 percent.

a-1

Calculate the EAC for the old computer and the new computer. (Negative amount 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? (Negative amount should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.)

Solutions

Expert Solution

A) if new machine is bought

Particulars 0 1 2 3 4 5 Total
Cost of new computer -1650000
Sale of old computer : 510000 + 38%(834000-510000) 633120
Savings in opertaing cost 299000 299000 299000 299000 299000
Depreciation -330000 -330000 -330000 -330000 -330000
PBT -31000 -31000 -31000 -31000 -31000
Tax savings @38% 11780 11780 11780 11780 11780
PAT -19220 -19220 -19220 -19220 -19220
Add depreciation 330000 330000 330000 330000 330000
Cash flow 310780 310780 310780 310780 310780
Salvage value ( 390000*.62) 241800
Total cash flow -1016880 310780 310780 310780 310780 552580
PVIF @ 12% 1 0.893 0.797 0.712 0.636 0.567
Present value -1016880 277482.143 247751.913 221207.065 197506.308 313548.732 240616.2
PVIFA(12%,5) 3.605
Annual benefit 66745.12

If old machine is continued

Particulars 1 2 Total
Depreciation 278000 278000
Tax savings @38% 105640 105640
Cash flow 105640 105640
Salvage value ( 129000 +38%(278000-129000) 185620
Total cash flow 105640 291260
PVIF @ 12% 0.893 0.797
Present value 94321.43 232190.69 326512.12
PVIFA(12%,5) 1.69
Annual benefit 193196.60

jeff jeffy answered 2 years ago
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