Question

You are the director of a company and you are considering updating all of your computers to new models. Using the old computers you have net cash flows of $78,274 per year and it is estimated that with the new computers net cash flows would grow to $104,104 per year. Updating all of the computers would initially cost $114,514. The estimated remaining life of the old computers is 1 year and the expected lifetime of the new computers is 4 years. The scrap value of the old computers is estimated to be $21,917 irrespective of whether they are scrapped today or in 1 year. The new computers have an estimated scrap value at the end of their life of $19,725.

Management is considering two different options:

• Option 1: Use the old computers for 1 more year and then replace them with the new computers that will then be replaced every 4 years in perpetuity.
• Option 2: Replace the old computers with the new computers now and replace them every 4 years in perpetuity.

The company's required rate of return is 18.0% pa. Assume that the cost of the computers, the cash flows that they generate and their scrap value remain constant over time.

a)What is the net present value of option 1? Give your answer in dollars to the nearest dollar.

NPV = $

b)What is the net present value of option 2? Give your answer in dollars to the nearest dollar.

NPV = $

c)Which option will you undertake?

	Option 1:	Use the old computers for 1 more year and then replace them with the new computers that will then be replaced every 4 years in perpetuity.
	Option 2:	Replace the old computers with the new computers now and replace them every 4 years in perpetuity.

Answer 1