Tate Enterprises is a nonprofit organization that has a cost of capital of 10 percent. The organization is considering the replacement of its computer system. The old system has a net book value of $3,000 and a remaining useful life of five years, with no expected salvage value at the end of the five years.
The company estimates the system's current salvage value to be $1,500. A new computer system will cost $10,000 and is expected to have a useful life of five years, with no salvage value. Annual cash operating costs are $4,000 for the old system and $2,000 for the new system.
A. What is the present value of the operating cash outflows for the old system?
B. What is the present value of the operating cash outflows for the new system?
C. What is the present value of the salvage value of the old system if it is replaced now?
D. Would you advise the organization to replace the system? Show calculations to support your recommendations.
Alfred Stein is about to invest $1,000. Alfred is a very cautious man and would like to have some expert advice on which two projects is best for him. He has not told you his exact cost of capital because he likes to keep such information private, but he has told you to consider 8 percent, 10 percent, and 12 percent in your calculations. He has also told you that the salesperson from whom he expects to purchase his equipment has given him the following expected cost savings patterns:
Year Project 1 Project 2
1 $600 $300
2 600 600
3 600 800
4 600 700
A. Calculate the present value of each project at each of Alfred's potential costs of capital and indicate which project is acceptable at each.
B. Calculate the payback period for each project. Does your recommendation to Alfred change?
C. Calculate the profitability index for each project, using a cost of capital of 10 percent. Which project would recommend Alfred pursue?