Five years ago, the City spent $30,000 to purchase a computerized radar system. Recently, a sales rep told the city manager about a new and improved radar system that can be purchased for $50,000. The rep also told the manager that the company would give the city $10,000 in trade on the old system. The new system will last 10 years. The old system will also last that long but only if a $4,000 upgrade is done in 5 years. The manager assembled the following information to use in the decision as to which system is more desirable:
Old System New System
Cost of radar system ...................... $30,000 $50,000
Current salvage value .................... $10,000 -
Salvage value in 10 years .............. $5,000 $8,000
Annual operating costs .................. $34,000 $29,000
Upgrade required in 5 years .......... $4,000 -
Discount rate .................................. 14% 14%
Required: Should the City purchase the new system or keep the old system (prove it)?