Question

In: Finance

Software Inc. is considering a replacement of its air conditioner system. The company has two systems...

Software Inc. is considering a replacement of its air conditioner system. The company has two systems to choose:
-   Matsu-Cool models cost $40,000 to purchase, result in electricity bills of $15,000 per year, and last for 5 years.
-   Tuba-Air models cost $60,000 to purchase, result in electricity bills of $10,000 per year, and last for 7 years.
Both systems are fully depreciated straight line. Assume that the company will replace the air conditioner when it wears out. The tax rate is 40%. The discount rate is 15%.
Which model should the company choose? Why?
(Excel format)

Solutions

Expert Solution

i)NPV of Matsu-Cool models is calculated as follows,

NPV = Present Value of Cash Inflows -Present Value of Cash Outflows

Year Cash Flows PV factor @ 15% PV of Cash Flows
0 (40,000)               1.00     (40,000.00)
1     (5,800)               0.87        (5,043.48)
2     (5,800)               0.76        (4,385.63)
3     (5,800)               0.66        (3,813.59)
4     (5,800)               0.57        (3,316.17)
5     (5,800)               0.50        (2,883.63)
NPV @ 15% (59,442.50)

Cash flows are calculated as follows,

Particulars Amount
Depreciation      8,000.00
A. Tax Savings on depreciation      3,200.00
Electricity charge    15,000.00
Tax on Electricity charge      6,000.00
B. After tax Electricity charge      9,000.00
Net cash flow (A-B)    (5,800.00)

ii)NPV of Tuba-Air models is calculated as follows,

NPV = Present Value of Cash Inflows -Present Value of Cash Outflows

Year Cash Flows PV factor @ 15% PV of Cash Flows
0 (60,000)        1.00     (60,000.00)
1     (2,571)        0.87        (2,236.02)
2     (2,571)        0.76        (1,944.37)
3     (2,571)        0.66        (1,690.76)
4     (2,571)        0.57        (1,470.22)
5     (2,571)        0.50        (1,278.45)
6     (2,571)        0.43        (1,111.70)
7     (2,571)        0.38           (966.70)
NPV @ 15% (67,341.37)

Cash flows are calculated as follows,

Particulars Amount
Depreciation      8,571.43
A. Tax Savings on depreciation      3,428.57
Electricity charge    10,000.00
Tax on Electricity charge      4,000.00
B. After tax Electricity charge      6,000.00
Net cashflow    (2,571.43)

iii)Which model should the company choose

The company should choose Matsu-Cool models.

A project is accepted when NPV is greater than zero and rejected when NPV is less than zero. In case of two projects with NPV which is less than zero i.e., Negative NPV, the project with least Negative NPV is choosen. Here Matsu-Cool models has least Negative NPV. So this model should be choosen.


Related Solutions

ABC Company sells two types of air conditioner systems – one for commercial use and one...
ABC Company sells two types of air conditioner systems – one for commercial use and one for residential use. The following inventory data was collected by the staff in the office of the controller for the first month of the company’s fiscal year. Commercial Air Conditioner Systems: Qty Unit Cost Total Cost Unit Selling Price Total Selling Price 12/31/2017 Balance             600             800      480,000 1/3/2018 Purchase             600             900      540,000 1/12/2018 Purchase             300             950...
3. GHI company wants to buy an air conditioner. There are two options in the market....
3. GHI company wants to buy an air conditioner. There are two options in the market. The discount rate is 17%. Option A: Super air conditioner cost $300 to purchase, can be used for 5 years, and the electricity bill is $150 per year. Option B: Excellent air conditioner cost $500 to purchase, can be used for 8 years, and the electricity bill is $100 per year. a) What are the equivalent annual costs (EAC) of the Super and Excellent...
3.GHI company wants to buy an air conditioner. There are two options in the market. The...
3.GHI company wants to buy an air conditioner. There are two options in the market. The discount rate is 17%. Option A: Super air conditioner cost $300 to purchase, can be used for 5 years, and the electricity bill is $150 per year. Option B: Excellent air conditioner cost $500 to purchase, can be used for 8 years, and the electricity bill is $100 per year. a) What are the equivalent annual costs (EAC) of the Super and Excellent air...
Coiner Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new...
Coiner Clothes Inc. is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: (a) Machine 200-3, which has a cost of $200,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $90,000 per year, and (b) Machine 380-6, which has a cost of $380,000, a 6-year life, and after-tax cash flows of $100,000 per year. Assume that both projects can be repeated. Knitting machine prices are not expected to rise...
An air conditioner using R134a as the working fluid operates on an ideal vapour compression system...
An air conditioner using R134a as the working fluid operates on an ideal vapour compression system between 0.3 and 0.8 MPa. If the specified capacity for air conditioning is 20 kW. What would be its capacity for food freezing for which the evaporator temperature -20oC. Show the cycle on a PH diagram and explain the effect of the changes to the compressor and condenser respectively.
A company must repair their main air conditioning system, and they are considering two alternatives. (1)...
A company must repair their main air conditioning system, and they are considering two alternatives. (1) purchase a new compressor for €20,000 that will have a future salvage value of €2,000 at the end of its 15-year life; or (2) purchase two high efficiency heat pumps for €28,000 that will have a future salvage value of €3,000 at the end of their 15-year useful life. The new compressor will save the company €6,500 per year in electricity costs, and the...
Star Wars & Company is considering the replacement of its old, fully depreciated blasters. Two new...
Star Wars & Company is considering the replacement of its old, fully depreciated blasters. Two new models are available: Type 168-3, which has a cost of $265,000, a 4-year expected life, and after-tax cash flows (labor savings and depreciation) of $96,500 per year; and Type 190-6, which has a cost of 465,000, a 8-year life, and after-tax cash flows of $101,800 per year. Blaster prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors) used...
Consider a company that has an intrusion detection system in half of its systems (50%), has...
Consider a company that has an intrusion detection system in half of its systems (50%), has bring your own device (BYOD) for 30% of its employees, and uses three systems (computers 40%, smartphones 25%, and cloud 35%). The probability of a breach is 11%. The probability of a breach given there is an intrusion detection is 15% The probability of a breach given there is no intrusion detection 25% The probability of a breach given employees’ use their own devices...
Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new...
Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $190,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $87,000 per year; and Machine 360-6, which has a cost of $360,000, a 6-year life, and after-tax cash flows of $98,300 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors)...
Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new...
Filkins Fabric Company is considering the replacement of its old, fully depreciated knitting machine. Two new models are available: Machine 190-3, which has a cost of $225,000, a 3-year expected life, and after-tax cash flows (labor savings and depreciation) of $95,000 per year; and Machine 360-6, which has a cost of $375,000, a 6-year life, and after-tax cash flows of $104,500 per year. Knitting machine prices are not expected to rise, because inflation will be offset by cheaper components (microprocessors)...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT