Question

QUESTION 5
The City of Jo’burg spent R330,000 to purchase a computerised billing system called Computerised Billing for All (C.B.F.A).
Recently, a sales representative from C.B.F.A. Computerised Billing Company told the city manager about a new and improved billing system that can be purchased for R550,000.
? The representative also told the manager that the company would give the city R110,000 in trade on the old system.
? The new system will last 10 years.
? The old system will also last that long but only if a R44,000 upgrade is done in 5 years.

The manager assembled the following information to use in the decision as to which system is more desirable:
Old system New system
Cost of the billing system R 330,000 R 550,000  
Current salvage value R 110,000 R -   
Salvage value in 10 years R 55,000 R 88,000  
Annual operating costs R 340,000 R 290,000  
Upgrade required in 5 years R 44,000 R -   
Discount rate 14% 14%

Required:
5.1 What is the City of Joburg’s net present value for the decision described above? Use the total cost approach. (11)
5.2 Should the City of Jo’burg purchase the new system or keep the old system?

Answer 1

Solution 5.1:

Analysis - Replacment Proposal
Particulars	Period	PV Factor	Amount	Present value
Cash outflows - New System (A):
Initial Cost	0	1	$550,000	$550,000
Annual operating cost	1-10	5.216116	$290,000	$1,512,674
Salvage Value	10	0.269744	-$88,000	-$23,737
Present value of cash outflows (A)				$2,038,936
Cash Outflows - Old System (B):
Current relevant cost of old system	0	1	$110,000	$110,000
Annual operating cost	1-10	5.216116	$340,000	$1,773,479
Upgradation cost	5	0.519369	$44,000	$22,852
Salvage Value	10	0.269744	-$55,000	-$14,836
Present value of cash outflows (B)				$1,891,496
Net Present Value - Replacement Decision (B - A)				-$147,440

Solution 5.2:

As net present value is negative, therefore Jo'burg should keep the old system.