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Vancouver Ltd. is considering the replacement of its old and relatively inefficient operating

system with new technology. The new technology, which will cost $4.8 million to purchase and

$200,000 to install has an estimated life of 4 years. If needed, the existing operating system

could also remain functional for the next 4 years, but it has no resale value now or at the end

of the 4 years because of its obsolescence. The new technology is expected to have a resale

value equal to 5% of its original cost at the end of the 4 years. The new technology will be

amortized on a straight-line basis over its useful life.

If the new system is installed, management believes that sales revenue can be increased by 30%

over their existing level of $7.5 million per year. While cost of goods sold is expected to remain

constant at 65% of sales revenue, annual system operating costs will be $1 million lower with the new

technology. As a result of the increased sales volume, management also believes that working

capital will increase by 30%. Currently, working capital is 10% of sales revenue.

Vancouver will borrow some of the money for the project. Interest on the loan of $25,000 will be paid

annually and the loan will be repaid at the end of the 4 years.

Vancouvers tax rate is 40%, its before tax cost of capital is 15% and the CCA rate is 20%.

Should Vancouver replace its operating system with the new technology?