TelCo must decide whether to replace a computer system with a new model. TelCo f
ID: 2731969 • Letter: T
Question
TelCo must decide whether to replace a computer system with a new model. TelCo forecasts net befoer-tax cost savings from the net computer over five years as given below (in $000). It has a 12% cost of capital, a 35% tax rate, and uses straight-line depreciation. Year 1 2 3 4 5 ($) 350 350 300 300 300 a. The new computer costs $1 million but TelCo is eligible for a 15% ITC in the first year. The ITC reduces TelCo's taxes by an amount equal to 15% of the equipment's purchase price. In addition, the old computer can be sold for $450,000. If the old computer originally cost $1.25 million and is three years old (depreciable, not economic, life is five years), what is the net investment required in the new system? Assume that there was no ITC on the old computer and that both computers are being depreciated to a zero salvage value. b. Estimate the incremental operating cash flows associated with the new system. c. If the new computer's salvage value at the end of five years is projected to be $100,000, should TelCo purchase it?
Explanation / Answer
New computer costs = $1,000,000
Less- sale of old computer = $450,000
Net investment required in the new system = $550,000
b. Incremental operating cash flows associated with the new system
No, company should not purchase the New computer
Year 1 2 3 4 5 Cash flow 350000 350000 300000 300000 300000 Less- Tax @35% 122500 122500 105000 105000 105000 Net cashflow 227500 227500 195000 195000 195000 Add-Tax savings due to depreciation 52500 44625 37931 32242 27405 Net operating cashflow 280000 272125 232931 227242 222405Related Questions
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