A university is considering upgrading its computing capabilities. The computer t

Question

A university is considering upgrading its computing capabilities. The computer that is now owned was purchased 2 years ago at a cost of $500,000. It was anticipated at the time of the purchase that annual operating costs would be $80,000, and that after 6 years of use the computer would be inadequate and therefore would be sold for $90,000. The existing unit has now a salvage value of $180,000 and, if retained for 4 more years, will have a salvage value of $40,000 at the end of that time. Its operating costs will increase at a rate of 3% per year from the current level of $80,000, and it will have to be supplemented immediately with a medium-size computer having initial cost, life, salvage value, and operating costs of $100,000, 5 years, $30,000, and $19,000, respectively. A new, larger computer with the desired capacity can be bought for $420,000. It is estimated that it will have a service life of 5 years, final salvage value of $120,000, and operating costs of $50,000 per year. As an alternative to these options, there is a possiblity of leasing a computer with sufficient capacity for a 4-year period. This alternative will require an initial payment of $10,000 and will have total lease costs of $140,000 payable at the beginning of each year. If the MARR is 12%, indicate the preferred alternative for a 4-year study period.

*solve using Annual equivalent worth (AE)

Solve using annual equivalent (AE) worth

17. A university is considering upgrading its computing capabilities. The com- puter that is now owned was purchased 2 years ago at a cost of $500,000. It was anticipated at the time of the purchase that annual operating costs would be $80,000, and that after 6 years of use the computer would be inadequate and therefore would be sold for $90,000. The existing unit has now a salvage value of $180,000 and, if retained for 4 more years, will have a salvage value of $40,000 at the end of that time. Its operating costs will increase at a rate of 3% per year from the current level of $80,000, and it will have to be supplement- ed immediately with a medium-size computer having initial cost, life, sal- vage value, and operating costs of $100,000, 5 years, $30,000, and $19,000, respectively. A new, larger computer with the desired capacity can be bought for $420,000. It is estimated that it will have a service life of 5 years, final salvage value of $120,000, and operating costs of $50,000 per year. As an alternative to these options, there is a possiblity of leasing a com- puter with sufficient capacity for a 4-year period. This alternative will require an initial payment of $10,000 and will have total lease costs of $140,000 payable at the beginning of each year. If the MARR is 12%, indicate the preferred alternative for a 4-year study period.

Explanation / Answer

Answer:

We need to compute the incremental benefits/ Cost between new computer and old one

hence the computation as follows :

Option 2 : leasing :

-10000*1 + (-140000*PVIFA (4 years , 12%) )

= -10000 - 140000*3.0373

= -435222 the total cost present value

Since the present value of cost for purchasing the new computer is lesser than the leasing hence they should not go for leasing and instead purcahse the new computer

Year Cash flow Formula discount 12% Present value 0 -$600,000 Cost of new +opportunity of old salvage 1 -$600,000 1 $30,000 Cost of new - old cost reduce 0.8928571429 $26,786 2 $32,400 0.7971938776 $25,829 3 $34,872 0.7117802478 $24,821 4 -$2,582 Cost + salvage of old - old cost 0.6355180784 -$1,641 5 $40,040 0.5674268557 $22,720 5 120000 salvage of new 0.5674268557 $68,091 Net present value -$433,394

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