Problem 10-36 Replacement Decisions [LO2] Suppose we are thinking about replacin

Question

Problem 10-36 Replacement Decisions [LO2]

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,250,000; the new one will cost, $1,510,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $250,000 after five years.

The old computer is being depreciated at a rate of $250,000 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 $370,000; in two years, it will probably be worth $115,000. The new machine will save us $285,000 per year in operating costs. The tax rate is 38 percent, and the discount rate is 12 percent.

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.)

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.)

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,250,000; the new one will cost, $1,510,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $250,000 after five years.

Explanation / Answer

Solution.

Calculation the EAC for the the new computer.

Depreciation = $1,510,000 - $250,000 / 5 = $252,000

EAC for New Computer is = $252,000

Cost of Old Computer :-

Calculation of depreciation = 1,250,000 -115,000 / 5 = 227,000

Tax @38%                           227,000 x 38%               =   86,260

Annual cost                                                              = 140,740

a2. What is the NPV of the decision to replace the computer now

Initial ash outflow                                                                 = 1,260,000

Cash inflow       ($272,460 x 3.60* (@12%)                          = (980,856)

Terminal value ($250,000 x .567**(@12%)                         = (141,750)

N.P.V    = (137,394)

* Furure value of 1 @12% At 5th year.

**Persent value of 1 @12% at 5th year.

See persent value / Future value Table.

particular's Amount New Computer Saving from new computer $285,000 Depreciation $252,000 P.B.T $33,000 Tax @38% $12,540 C.F.A.T $20,460 Annual Cash inflow $252,000+$20,460 = $272,460

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