Most businesses replace their computers every two to three years. Assume that a
ID: 2734666 • Letter: M
Question
Most businesses replace their computers every two to three years. Assume that a computer costs $3,000 and that it fully depreciates in 3 years, at which point it has no resale value and is thrown away.
a. If the interest rate for financing the equipment is 8 percent, what is the minimum annual cash flow that a computer must generate to be worth the purchase?
Instruction: Round your answers to the nearest dollar.
The minimum annual cash flow must be at least $ _____.
b. Suppose the computer did not fully depreciate but still had a $400 value at the time it was replaced. What is the minimum annual cash flow that a computer must generate to be worth the purchase?
The minimum annual cash flow must be at least $ _____.
Explanation / Answer
Computer cost = $3000
interest rate = 8%
Minimum annual cashflow that computer mus generate to be worth the purchase = computer cost / [(1/1+r)n +(1/(1+r)n+1....+ (1/ 1+r)n+2]
= 3000 / [(1/1+.08)1 + (1/(1+0.08)2 + (1/ 1+0.08)3]
= 3000 / (0.9259 + 0.8573 + 0.7938)
= 1164.09
b) If computer did not fully depreciate but still had a $400 value at the time it was replaced, minimum annual cash flow that a computer must generate to be worth the purchase =
= [3000 - 400* [1/(1+0.08)3] / [(1/1+.08)1 + (1/(1+0.08)2 + (1/ 1+0.08)3]
= [3000- 317.53] / [0.9259 + 0.8573 + 0.7938]
= 1040.88
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