Madison Company is considering replacing its existing mainframe computer with a new model manufactured by a different company. The existing computer was acquired three years ago, has a remaining life of five years, and will have a salvage value of $10,000. The book value is $200,000. Straight-line depreciation with a half-life convention is being used for tax purposes. The computer's cash operating costs, including software, personnel, and other supplies, total $100,000 per year.
The new computer has an initial cost of $500,000 and will have cash operating costs of $50,000 per year. The new computer will have a life of five years and a salvage value of $100,000 at the end of the fifth year. MACRS depreciation will be used for tax purposes. If the new computer is purchased, the old one will be sold for $50,000. The company needs to decide whether to keep the old computer or buy the new one. The cost of capital is 12 percent. The tax rate is 40 percent.
Required
Compute the NPV of each alternative. Should the company keep the old computer, or buy the new one?