Firm is contemplating replacing a computer (D) it purchased three years ago for

Question

Firm is contemplating replacing a computer (D) it purchased three years ago for 6,000. In two years it will have a salvage value of $800. Operating a maintenance costs have been $1,000 per year. The computer currently has a trade in value of $3,000 toward a new computer (C) that costs $5,000 and has a five (5) year live. The computer will have annual operating and maintenance costs of $500 per year and a expected salvage value of $1,000 at the end of the five (5) years. Company's policy demand that any computer should be replaced after five (5) years in service. Determine is the current computer should be replaced. Use a 9% rate of return.

1. EACc= $1,618.36 and EACd= $2,322.63, Should be replaced

2. EACc= $1,637.62 and EACd= $1,618.36, should be replaced

3. EACc= $1,618.36 and EACd= $2,322.63, should not be replaced

4. EACc= $2,322.63 and EACd= $1,618.36, should not be replaced

Explanation / Answer

Hi,

Please find the detailed answer as follows:

Step 1: Calculate NPV of both the Systems

NPV (D)

Today's Value = -3000

Annual Cost = -1000

NPV = -3000 -1000/(1+.09)^1 -1000/(1+.09)^2 + 800/(1+.09)^2 = -4085.77

NPV (C)

Initial Investment = -5000

Annual Cost = -500

NPV = -5000 - 500/(1+.09)^1 - 500/(1+.09)^2 - 500/(1+.09)^3 - 500/(1+.09)^4 - 500/(1+.09)^5 + 1000/(1+.09)^5 = -6294.89

Step 2: Calculate EAC

EAC (D) = NPV (D)/PVIFA(2Years, 9%) = -4085.77/1.7591 = -2322.63

EAC (C) = NPV (C)/PVIFA(5Years, 9%) = -6294.89/3.8897 = -1618.36

Option 1 ( EACc= $1,618.36 and EACd= $2,322.63, Should be replaced) is the correct answer.

Thanks.

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