You own a small business as a gardener. Your car is getting rather old, and you are considering replacing it. To keep your current car, you believe that you will have to spend:

• $500 immediately to repair a problem with the engine,
• $100 per year in additional maintenance (above the usual amount for other cars),
• This car will last you 4 more years.
• The book value of this car is $4,000, and you believe you can sell it for $2,000 today if you wanted to do so.

Alternatively, you may buy a new car for $20,000. You know the following:

• This new car comes with free servicing for the next 4 years, which you estimate to be worth $400 per year,
• Because the new car will be more reliable, you believe you will be able to generate an additional $1,000 revenue each year in business,
• You plan on retiring after 4 years, at which point the car will be considered worthless to you.

You are required by law to use straight line depreciation for your car, the tax rate for your business is 15%, and you currently have a business loan charging interest at 6% p.a. (take this as your rate of return).

For the new car, calculate the Cash Flow from Operating Activities (CFOA) in the first year.

Calculate the NPV of buying the new car.

Calculate the NPV of replacing the old car with the new car

Q2. The servers of your company, Meteor Inc., have just broken down. Whist you were able to salvage the data, the servers themselves have been deemed completely beyond repair. You ask for a quote to replace the servers, and you receive the following information:

• A new server would cost $200,000 to purchase and install,
• This new server is expected to last 10 years,
• Server maintenance and the license fee for the software will total $5,000 per year

Your company's rate of return is 10% p.a., the corporate tax rate is 30%, and your company uses straight line depreciation for computer equipment.

What is the Equivalent Annual Cost (EAC) of installing the new server? 

Calculate the NPV of installing this new server.

Answer rating: 100% (QA)

Q1 Buying a New Car To calculate the Cash Flow from Operating Activities CFOA in the first year for the new car we need to consider the additional revenue savings from free servicing and tax implicati... View the full answer