Suppose we are thinking about replacing an old computer with a new one. The old one cost us $650,000; 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 about $140,000 after five years. The old computer is being depreciated at a rate of $130,000 per year. It will be completely written off in three years. If we don't replace it now, we will have to replace it in two years. We can sell it now for $230,000; in two years 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 percent.
Suppose we consider only whether we should replace the old computer now with out worrying about what's going to happen in two years. Calculate the NPV of the project.
{ Hint: In 2 years time you sell the old machine,s o you need to calculate the cashflows for it:
Aftertax salvage value = $90,000 + ($130,000 – 90,000)(.38) = $105,200}