Reference no: EM132889338

Question - Equipment replacement - Copy Center is considering replacing one of its copiers. The new copier will cost $90,000; it has an expected life of three years with zero salvage value. The company expects that the new copier will generate $40,000, $35,000, and $25,000 in after-tax cash flows, respectively, in the first, second, and the third year of operations. The firm's manager, however, informs you that this estimate does not include the depreciation tax shield. The old copier has a book value of $5,000 but can be sold for $12,000. The old copier will last three more years with careful maintenance. Demand, though, is expected to be lower because the old copier lacks the features of the new copier. The company projects that the old copier will generate $10,000, $8,000, and $5,000, respectively, in after-tax cash flows over the next three years. Again, this estimate excludes any tax shield arising from depreciating the old copier. At the end of three years, this old copier will have no salvage value.

Copy Center uses a cost of capital of 12% for discounting purposes. Both copiers would be depreciated on a straight-line basis over a period of three years. The corporate tax rate is 25%. Assume that all operating cash flows and taxes are paid at the end of each year.

Required -

a. Compute the net present value of the new copier, assuming that the company goes ahead with the replacement decision.

b. Using Excel, compute the internal rate of return from investment in the new copier (round off to the nearest percentage), assuming that the company goes ahead with the replacement decision.

c. What is the net present value from keeping the old copier?

d. Under the net present value method, which is the better option? What assumption does this method make with respect to the money that is freed up if the company were to retain the old copier? Does this assumption seem reasonable?

e. Discuss some of the qualitative/nonfinancial factors that may be relevant to this decision.