A company’s current computer system has a salvage value now of $5,000, which wil

Question

A company’s current computer system has a salvage value now of $5,000, which will fall to $4,000 by the end of the year. The cost of the lower productivity linked to this computer system is $3,000 this year. A potential new system costs $12,000 and has the following salvage values and lost productivity for each year.

The company uses a before-tax interest rate of 10%. Should the company engineering replace its computer system this year? Why?

Year 0 1 2 3 4 Salvage Value $12,000 $9,000 $7,000 $5,000 $3,000 Lost Productivity -- $0 $1,000 $2,000 $3,000

Explanation / Answer

The company should replace the system this year because in the current year the salvage value of old machine is 5000 so the net cost of new machine is 7000 , next year the salvage value is 4000 hence the net cost would be 8000

Also the the salvage value of the new machine reduces every year so a delay of one year would result in lower salvage value and a higher lost productivity. Hence the machine should be replaced in the current year.

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