Replacement Decisions
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Suppose we are thinking about replacing an old computer with a new one. The old one cost us $390,000; the new one will cost $780,000. The new machine will be depreciated straight-line to zero over its five-year life. It will probably be worth $90,000. The new machine will save us $125,000 per year in operating costs. The tax rate is 38 percent and the discount rate is 14%
a. Suppose we recognize that if we don't replace the computer now, we will be replacing it in two years. Should we replace it now or should we wait?
b. Suppose we only consider whether or now we should replace the old computer now without worrying about what's going to happen in two years. What are the relevant cash flows? Should we replace it or not?
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Solution Summary
The solution explains how to decide when to replace the equipment - now or later
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a. Whether to replace now or to wait for two years depends on whether it is beneficial to replace. If it is beneficial, then we replace now else we wait for two years since then in any case we have to place. The benefit is the savings - the cost. We find the NPV of the machine. If the NPV is positive we replace now. If the NPV is negative, that implies that we should not replace the machine any time, but since the machine has to be ...
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