A company wants to invest in a new computer system, and management has narrowed
ID: 2675093 • Letter: A
Question
A company wants to invest in a new computer system, and management has narrowed the choice to systems a and b. System a requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $60,000 at the end of each of the next 2 years. The system could be replaced every 2 years, and the cash inflows and outflows would remain the same. System b also requires an up-front cost of $100,000, after which it would generate postive after tax cash flows of $48,000 at the end of each of the next 3 years. System b can be replaced every 3 years, but each time the system is replaced, both the cash outflows and cash inflows would increase by 10%. The company needs a computer system for 6 years, after which the current owners plan to retire and liquidate the firm. The company's cost of capital is 11%. What is the NPV (on a 6 yr extended basis) of the system that adds the most value? Answer choices: $17,298.30 or $22,634.77 or $31,211.52 or $38,523.43 or $46,143.21Explanation / Answer
A company wants to invest in a new computer system, and management has narrowed the choice to systems a and b. System a requires an up-front cost of $100,000, after which it generates positive after-tax cash flows of $60,000 at the end of each of the next 2 years. The system could be replaced every 2 years, and the cash inflows and outflows would remain the same. System b also requires an up-front cost of $100,000, after which it would generate postive after tax cash flows of $48,000 at the end of each of the next 3 years. System b can be replaced every 3 years, but each time the system is replaced, both the cash outflows and cash inflows would increase by 10%. The company needs a computer system for 6 years, after which the current owners plan to retire and liquidate the firm. The company's cost of capital is 11%. What is the NPV (on a 6 yr extended basis) of the system that adds the most value?
Answer choices:
$17,298.30 or
$22,634.77 or
$31,211.52
or $38,523.43
or $46,143.21
Time
System A
0
-100,000
-100,000
1
60,000
60,000
2
60,000-100,000=-40,000
60,000-110,000=-62000
3
60,000
60,000
4
60,000-100,000=-40,000
60,000
5
60,000
60,000
6
60,000
60,000
I/YR = 11. This
NPVA = $6,796.93. NPVB = $31,211.52.
Time
System A
0
-100,000
-100,000
1
60,000
60,000
2
60,000-100,000=-40,000
60,000-110,000=-62000
3
60,000
60,000
4
60,000-100,000=-40,000
60,000
5
60,000
60,000
6
60,000
60,000
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