4. A small business is considering the purchase of one of the following computer

Question

4. A small business is considering the purchase of one of the following computers Initial Cost Salvage Value Useful Life Annual Maintenance Computer A $3,900 $1,800 10 years $390 ComputerB $5,500 $3,100 10 years $276 (years 1 to 5) $425 (years 6 to 10) 6% Interest Rate 6% a) Which computer should the business purchase? b) What first-cost is necessary for Computer A to Breakeven? c) What salvage value for Computer B will result in Computers A&B; being equivalent? d) What is the book value of Computer B in year 4 using straight-ine depreciation?

Explanation / Answer

a) Present Value of cash outflows = Initial Cost + present value Annual maintenance - Present value of salvage value

Computer A = $3900 + $390 x PVIFA (6%, 1-10 years) - $1800 x PVIF (6%, year 10)

or, Computer A = $3900 + $390 x 7.3600870511 - $1800 x 0.55839477687 = $5765.32

Computer B = $5500 + $276 x PVIFA (6%, 1-5 years) + $425 x PVIFA (6%, 6-10 years) - $3100 x PVIF (6%, Year 10)

Or, Computer B = $5500 + $276 x 4.21236378546 + $425 x 3.14772326564 - $3100 x 0.55839477687 = $6269.37

Computer A should be purchased as it has less present value of cash outflows.

b) For the two computers to breakeven -

PV of cash outflows of computer A = PV of cash outflows of computer B

Initial Cost + $390 x 7.3600870511 - $1800 x 0.55839477687 = $5500 + $276 x 4.21236378546 + $425 x 3.14772326564 - $3100 x 0.55839477687

Or, Initial Cost = $4404.05

c) Similar to part b, for the two computers to be equivalent, we have -

PV of cash outflows of computer A = PV of cash outflows of computer B

$3900 + $390 x 7.3600870511 - $1800 x 0.55839477687 = $5500 + $276 x 4.21236378546 + $425 x 3.14772326564 - Salvage Value x 0.55839477687

Or, Salvage Value = $4002.67

d) Depreciation per year for computer B = ($5500 - $3100) / 10 = $240

Book value at the beginning of year 4 = $5500 - $240 x 3 = $4780

Book value at the end of year 4 = $5500 - $240 x 4 = $4540

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