Doherty Industries wants to invest in a new computer system. The company only wants to invest in one system, and has narrowed the choice down to System A and System B.
System A requires an initial cost of $100,000 and then generates positive after-tax cash flows of $60,000 at the end of each of the next two years. The system can be replaced every two years with the cash inflows and outflows remaining the same.
System B also requires an initial cost of $100,000 and then generates positive after-tax cash flows of $42,500 at the end of each of the next three years. System B can be replaced every three years.
The company needs a computer system for the 6-year period, after which time the current owners plan on retiring and liquidating the firm. The company's cost of capital is 11 percent.
Use either the replacement chain approach or the equivalent annual cash flow approach and show which system should be chosen.
For the replacement chain analysis, we would consider the equal time period for the two Systems. Since System A has a life of 2 years and B ahs a life of 3 years, ...
Explains the concepts of time value of money through a very simple situation.