Question

A company is considering replacing the computer it currently uses. It was 3 years ago at a cost of $ 10,000. The operation and maintenance costs for that computer have been and will remain in the future at $ 1,000 per year. If a new computer is purchased, a bonus of $5,000 would be obtained in exchange for the current one. The cost of the new computer is $15,000 with an estimated useful life of 5 years and a salvage value of $3,000; with operating and maintenance expenses of $1,500.

If the current computer is kept, it will be necessary to purchase another small computer to satisfy the demand in processing capacity. The current computer still has a 5-year lifespan, with a salvage value of $500. The cost of the small computer is $5,000. At the end of its 5-year useful life, the salvage value will be $800. The operating and maintenance costs are $600 yearly.
 
a) Using the NPV method and a MARR of 30%, determine the best choice.

Note: Consider that the costs and investments made in the past are not considered in the calculation of cash flows.

Answer 1

Since, tax rate is not provided in the question, the taxes are ignored. Hence, there would not be any effect of depreciation in the cash flows under both the options.

Savings in operation costs p.a = Op. costs of old m/c + small m/c - op. costs of new m/c = 1000+600-500 = $100 p.a

Incremental residual value in yr 5 = RV of new m/c - opd m/c - small m/c = 3000-500-800 = $1,700

Additional investment now = Bonus amount payable - Cost of small machine = 5000-5000 = $0

So, the net present value for replacement decision shall be = Present value of savings in operation costs + Present value of incremental residual value

= [100×PV of annuity (30%, 5 years)] + [1700×PV interest (30%, 5th year)]

= (100×2.43557)+(1700×0.26933)

= 243.56 + 457.86

= $ 701.42

Since, the net present value is positive, opting for replacement of machine may be the right choice.