A firm is considering the purchase of a new computer that is expected to produce annual net savings in labour costs of £8000 in each of the 6 years of its operational life.
The computer has an initial cost of £30000, and annual maintenance costs of £1000. All savings and maintenance costs accrue at the end of each relevant year.
The company has access to funds at the current market interest rate of 14% per annum, compounded annually, and wishes to decide whether the purchase of the computer is a worthwhile investment.
(a) By calculating the NPV of the proposed expenditure decide whether the computer should be purchased.
(b) If the market rate of interest fell to 8.5% per annum would the decision reached in (a) above be altered?
(c) In an attempt to finalize the sale, the computer salesperson offers the firm a ‘trade-in' after 6 years, the terms of which guarantee a £7500 reduction in the price of a replacement computer. Would such an offer alter the decision reached in (a) above (i.e. at the 14% interest rate)?