Problem: Suppose we are thinking about replacing an old computer with a new one. The old one cost us $390,000; 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 $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%
1) Suppose we recognize that if we don't replace the computer now, we will be replacing it in two years. Should we replace it now or should we wait?
2) Suppose we only consider whether or now we should replace the old computer now without worrying about what's going to happen in two years. What are the relevant cash flows? Should we replace it or not?