Copy Center, Inc., offers a variety of document and computer services to the business community in midtown Cleveland. It is considering replacing one of its copiers. The old copier has a book value of $5,000 but can be sold for $12,000. The new copier being considered will cost $90,000 and offers a number of attractive features. The expected life is three years with no expected salvage value at the end of its life. 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, tells you that this estimate does not include the depreciation tax shield.

On the other hand, the old copier is in a relatively good condition and can 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. Taking these factors into account, the company projects that the old copier will generate $10,000, $8,000, and $5,000 in after tax cash flows over the next three years. Again, this estimate excludes any tax shield arising from depreciating the 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. Copy Center depreciates its copiers on a straight-line basis over a period of three years. The corporate tax rate is 25%, and all taxes are paid at the end of each year. If Copy Center decided to retain the old copier, it will depreciate the remaining $5,000 book value over the next three years.

Required:

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

b. 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.