Question

1. Suppose we are thinking about replacing a series of old computer systems with new computers. The old ones cost us $420,000 one year ago and is depreciated at a rate of $140,000 a year and will be completely written off in 3 years.It can be sold for $190,000 now or sold for $80,000 in two years.

The new machine will cost $368,000 a year and will be depreciated at a rate of 10% a year. It is expected to be worth $198,000 after five years. The new machine will save $130,000 in maintenance costs per year. The tax rate is 38% and the discount rate is 13%.

Should we replace the computer now or should we replace the computer in two years or should we not replace the computer at all? What are the relevant cash flows? Explain.

Answer 1

a) under old machine.

	a year ago(1st year)	2 nd year	3rd year
sale value		190000	80000
less- cost of the assets opening - depreciation	420000 (140000)	280000 (140000)	140000 (140000)
value of assest	280000	140000	0
balance		50000	80000
tax 38%		(19000)	(30400)

cash flow of old machine.

year	sale value(a)	tax(b)	cash balance(a-b)	discount date 13%	value after discount rate
2	190000	19000	171000	0.783	133893
3	80000	30400	49600	0.693	34372

in year 2 only the old machine should sold to get higher cash flow. to buy the new machine.