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ITC Corporation considering purchasing a new minicomputer for data processing. the purchase price is $ 150,000 delivered and installed.
1. ITC Corporation considering purchasing a new minicomputer for data processing. the purchase price is $ 150,000 delivered and installed. It has been estimated that the new computer will produce annual savings of $ 50,000 in enhanced productivity as compared with the current computer. ITC assume the new computer will have an economic life of 5 years, at which time it will be essentially obsolete and have zero salvage value over the costs of removal. The present computer, which is fully depreciated, is in good working order and could conceivably be used for at least 5 more years, but its present salvage is zero, net of all costs of removal. The company has adopted a hurdle rate of 12%, . For each of calculation, assume that the margin tax rate is 50%, that the new computer will be straight line depreciated over no less than five years, and that the cash flows occur in a lump sum at year end.
a. Show the company cannot justify the computer on purely economic grounds. What happens if the flows are assumed to occur quarterly.
b. What would the savage value of the present computer have to make the new computer attractive? Assume the salvage income is subject to the 50% tax rate. Why does the old computer's salvage value influence the new computer's attractiveness?
c. Suppose again that the present computer has zero salvage value. What would the salvage value of the new computer at the end of 5 year life have to be to make the new computer attractive? Assume the book value of the computer at the of year five is zero?
