The derivatives trader you are working for, IHA Ltd, is looking at developing an optimal replacement policy for its document scanning machine. The cost of running a machine for its four-year life, reflecting acquisition and maintenance costs, after depreciation and tax effects, is:

The salvage value of the scanner is $16,000, $13,500, $10,000 and $6,000 at the end of the first, second, third and fourth years respectively. The required rate of return for the document scanning machine is the same as the required rate of return for IHA Ltd. If the expected return on the market 10% p.a., the risk free rate of interest is 6% p.a., the correlation of IHA Ltd with the market is 0.6, the standard deviation of the market is 0.15, the standard deviation of IHA Ltd is 0.6, and the corporate tax rate is 30%.

How frequently should the scanner be replaced?

Transcribed Image Text:

Year Scanning Machine 0 1 2 3 4 Net Cash Flow -22,000 -2,800 -3,400 -3,100 -2,900 Year Scanning Machine 0 1 2 3 4 Net Cash Flow -22,000 -2,800 -3,400 -3,100 -2,900

Answer rating: 100% (QA)

Given Expected return on the market Rm 10 Riskfree rate Rf 6 Beta of IHA Ltd Use the ... View the full answer