Tate Enterprises is a nonprofit organization that has a cost of capital of 10 pe

Question

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. Required What is the present value of the operating cash outflows for the old system? What is the present value of the operating cash outflows for the new system? What is the present value of the salvage value of the old system if it is replaced now? Would you advise the organization to replace the system? Show calculations to support your recommendation.

Explanation / Answer

Answer A Present value of the operating cash outflows for the old system Year Cash outflows PV factor = 1/(1+0.10)^n Present Value 1 4000 0.909090909                       3,636.36 2 4000 0.826446281                       3,305.79 3 4000 0.751314801                       3,005.26 4 4000 0.683013455                       2,732.05 5 4000 0.620921323                       2,483.69 Present value of operating cash outflow                     15,163.15 Answer B Present value of the operating cash outflows for the NEW system Year Cash outflows PV factor = 1/(1+0.10)^n Present Value 1 2000 0.909090909                       1,818.18 2 2000 0.826446281                       1,652.89 3 2000 0.751314801                       1,502.63 4 2000 0.683013455                       1,366.03 5 2000 0.620921323                       1,241.84 Present value of operating cash outflow                       7,581.57 Answer C Present value of the salvage value of old system = $1500 Answer D Net present value of cash outflow if old system is replaced with new system = Cost of new computer system - salvage value of old system + Present value of operating cash outflow of new system Net present value of cash outflow if old system is replaced with new system = $10000 - $1500 + $7581.57 = $16081.57 As the present value of cash outflow of old system is less compared to net present value of cash outflow of new system the advise is that the organisation should not replace the old system.

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