# Replacement of an asset

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $576,000; the new one will cost $1,168,000. The new machine will be depreciated straight-line to zero over its 5-year life. It will probably be worth about $216,000 after five years.

The old computer is being depreciated at a rate of $192,000 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 $304,000; in two years, it will probably be worth $128,000. The new machine will save us $208,000 per year in operating costs. The tax rate is 40 percent and the discount rate is 10 percent.

Required:

(a)

Suppose we recognize that if we don't replace the computer now, we will be replacing it in two years. Should we replace now or should we wait? Hint: What we effectively have here is a decision either to "invest" in the old computer (by not selling it) or to invest in the new one. Notice that the two investments have unequal lives. The EAC for investing in the new computer is $_____, while the EAC for investing in the old computer is $. Thus, we (should/should not) replace the old computer. (Do not include the dollar sign ($)_____. Negative amounts should be indicated by a minus sign. Round your answers to 2 decimal places. (e.g., 32.16))

(b)

Suppose we consider only whether we should replace the old computer now without worrying about what's going to happen in two years. Should we replace it or not? Hint: Consider the net change in the firm's aftertax cash flows if we do the replacement. The NPV is $_____ and thus we(should/should not) replace the old computer. (Do not include the dollar sign ($). Negative amount should be indicated by a minus sign. Round your answer to 2 decimal places. (e.g., 32.16))

https://brainmass.com/business/discounted-cash-flows-model/replacement-of-an-asset-470914

#### Solution Preview

See your assistance attached.

New computer cash flows - $1,168,000, annual depreciation 233,600; Salvage value 216,000; Savings from new machine $208,000 per year; life 5 years

Operating Cash Flow = ($208,000)(1 – .40) + ($1,168,000 / 5)(.40) = $218,240

Notice that the costs are positive, which represents a cash inflow. The costs are positive in this case

since the new computer will generate a cost savings. The only initial cash flow for the new computer

is cost of $1,168,000. We next need to calculate the aftertax salvage value, which is:

Aftertax salvage value = $216,000(1 – .4) = $129,600

Now we can calculate the NPV of the new computer as:

NPV = –$1,168,000 + $218,214 (PVIFA10%,5) + $129,600 / 1.105

NPV = I will allow you to work the NPV ...

#### Solution Summary

Suppose we are thinking about replacing an old computer with a new one. The old one cost us $576,000; the new one will cost $1,168,000. The new machine will be depreciated straight-line to zero over its 5-year life. It will probably be worth about $216,000 after five years.

The old computer is being depreciated at a rate of $192,000 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 $304,000; in two years, it will probably be worth $128,000. The new machine will save us $208,000 per year in operating costs. The tax rate is 40 percent and the discount rate is 10 percent.

Asset replacement and capital budgeting

The plant has accumulated savings of $60,000 to acquire a new machine for quality assurance of its products. The new quality control machine cost $80,000. The extra $20,000 needed to acquire the new machine will be finance through a loan at 6% annual interest with the principal ($20,000) due at the end of the third year. The income tax rate is 0.35. The new equipment will save $35,000 each year and its economic life is 3 years. The salvage value is $30,000. Does the acquisition of this new machine satisfy the 6% minimum rate? Compute the after tax rate of return of this alternative for year two. Solve this problem using the straight line and the MACRS depreciation methods. Which depreciation method is best for year two?

Four years ago a company purchased a new copy machine. Due to deterioration, soon a new copy machine will be needed. The annual maintenance cost for the existing machine is $1,600 and increasing 100 each year. An identical copy machine can be purchased now to replace the presently owned assets. The presently owned copy machine losses each year $10,000 in resale value, compare the assets with at 10% per year and compute when the presently owed should be replace.

Same model as presently owned

Present value (when new) $75,000

Present value of new copy machine $85,000

Annual cost (old copy machine) 1,100

Annual cost (new copy machine) 1,600 and increasing

Salvage value (both machine) 15,000

Life in years (both machine) 6