Question

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $1,900,000; the new one will cost, $2,313,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth about $615,000 after five years. The old computer is being depreciated at a rate of $448,000 per year. It will be completely written off in three years. If we don't replace it now, we will have to replace it in two years. We can sell it now for $657,000; in two years, it will probably be worth $195,000. The new machine will save us $413,000 per year in operating costs. The tax rate is 22 percent, and the discount rate is 11 percent. a-1. Calculate the EAC for the the old computer and the new computer. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.) a-2. What is the NPV of the decision to replace the computer now? (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answer to 2 decimal places, e.g., 32.16.) a-1. Old computer EAC New computer EAC a-2. NPV

Answer 1

	EAC of old Computer:
	Annual Depreciation	$448,000
	Annual Depreciation tax shield	$98,560	(448000*22%)
	Book Value at the end of year 2	$448,000
	Salvage Value at end of year2	$195,000
	Loss on salvage	$253,000
	Tax saving on loss=253000*22%	$55,660
	Cash flow on salvage	$250,660	(195000+55660)
	Total Cash Flow in year 2	$349,220	(250660+98560)
		N	CF	PV=CF/(1.11^N)
		Year	Cash Flow	Present Value
		0	($657,000)	($657,000)
		1	$98,560	$88,793
		2	$349,220	$283,435
			SUM	($284,772)
	Net Present Value of Costs	$284,772
	Equivalent Annual Cost(EAC)	$166,288.20	(Using PMT function of excel with Rate =11%, Nper=2,Pv=-284772)
	EAC of NEW Computer:
	Annual Depreciation	$462,600	(2313000/5)
	Annual Depreciation tax shield	$101,772	(462600*22%)
	Book Value at the end of year 5	$0
	Salvage Value at end of year5	$615,000
	Gain on salvage	$615,000
	Tax saving on gain=615000*22%	$135,300
	Cash flow on salvage	$479,700	(615000-135300)
	Total Cash Flow in year 5	$581,472	(101772+479700)
		N	CF	PV=CF/(1.11^N)
		Year	Cash Flow	Present Value
		0	($2,313,000)	($2,313,000)
		1	$101,772	$91,686
		2	$101,772	$82,600
		3	$101,772	$74,415
		4	$101,772	$67,040
		5	$581,472	$345,075
			SUM	($2,138,713)
	Net Present Value of Costs	$2,138,713
	Equivalent Annual Cost(EAC)	$578,672	(Using PMT function of excel with Rate =11%, Nper=5,Pv=-2138713)
a1	Old Computer EAC	$166,288.20
	New Computer EAC	$578,672
			a2 NPV of the decision to replace now ($1,656,000) (-2313000+657000) Initial Cash Flow NCF=l+C+F+G PV=NCF/(1.11^N) F-D-E N в C-A-B D G Salvage Cash Incremen Salvage Flow of tal Present Value of Depreciation Salavage Saving in Depreciation tax tax shield of Incremen Cash Flow Old Net Net of New shield of New tal Tax IncrementalCa IncrementalCash OLD Compute Cash Operating Initial Cash Flow Computer Shield sh Flow Computer Computer r Flow Flow Year Costs ($1,656,000) $416,212 $165,552 ($1,656,000) ($1,656,000) $98,560 $101,772 $3,212 $413,000 $374,965.77 1 $250,660 $101,772 $98,560 $3,212 $413,000 $134,365.72 2 -250660 $413,000 $101,772 $101,772 $514,772 $376,396.85 0 $339,096.26 $101,772 $101,772 $413,000 $514,772 4 $101,772 $101,772 $479,700 $413,000 $994,472 $590,170.73 5 479700 $158,995 |а2 $158,995 NPV SUM =PMT(11%,2,-F18) F19 A В C E G Н J К M Total Cash Flow in year 2 $349,220 (250660+98560) 11 PV=CF/(1.11AN) 12 CF 13 Year Cash Flow Present Value ($657,000) ($657,000) 14 0 $98,560 $88,793 15 1 $349,220 $283,435 16 2 ($284,772) 17 SUM $284,772 Net Present Value of Costs 18 $166,288.20 Using PMT function of excel with Rate 11%, Nper-2,Pv-284772) 19 Equivalent Annual Cost(EAC) 20 21 Спробато AllghmerIL fix X -РMT(11%,5,-F40) F41 A В D Е F G Н К $101,772 (462600*22 %) Annual Depreciation tax shield 24 Book Value at the end of year 5 $0 25 $615,000 Salvage Value at end of year5 Gain on salvage 26 $615,000 27 Tax saving on gain=615000 22% Cash flow on salvage $135,300 28 $479,700 (615000- 135300) 29 $581,472 (101772+479700) Total Cash Flow in year 5 30 PV=CF/(1.11AN) 31 N CF Cash Flow Present Value 32 Year ($2,313,000) $101,772 ($2,313,000) $91,686 33 0 34 1 $101,772 $82,600 35 2 $101,772 $74,415 36 $101,772 $67,040 37 4 $581,472 $345,075 38 5 ($2,138,713) 39 SUM $2,138,713 $578,672.26 Using PMT function of excel with Rate 11 % , Nper-5,Pv-2138713 Net Present Value of Costs 40 Equivalent Annual Cost(EAC) 41 A2