Question

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 $130,00 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

Scenario 1: Not Replace Computer

Saving $ 368000

Loss of $13000*2= 26000 Maintanance cost

Cashflow= 342000 unrealised profit is there

Scenario 2: Replacing Computer Now

+Selling old Computer - $190000

-New Machine Cost-$368000 - 47840 Discount(13%) + 121661 =441821

+ Benefit of Mintanance cost(13000*2)=$26000

Cashflow= $225821 cost occured

Scenario 3 : Replacing Computer in Two Years

+Selling Old Computer: $80000

- Cost of New Computer=$368000 - 69920Dep(36800+33120) -38750(Disc)+ 98545(Tax) = $357875

- Loss of Maintanance Cost = $26000

Cashflow= 303875 cost Occured

Answer:

Considering All the Scenario the best Option would be Not Replaceing Computer is Favourable