A medium-sized manufacturing company is considering the purchase of a small computer in order to reduce the cost of its data processing operations. At the present time, the manual bookkeeping system in use involves the following direct cash expenses per month:
|
Salaries
|
$7,500
|
|
Payroll taxes and fringe benefits
|
1,700
|
|
Forms and supplies
|
600
|
|
$9,800
|
Existing furniture and equipment are fully depreciated in the accounts and have no salvage
value. The cost of the computer, including alterations, installation, and accessory equipment, is $100,000.This entire amount is depreciable for income tax purposes on a double-declining basis at the rate of 20 percent per annum. Estimated annual costs of computerized data processing are as follows:
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Supervisory salaries
|
$15,000
|
|
Other salaries
|
24,000
|
|
Payroll taxes and fringe benefits
|
7,400
|
|
Forms and supplies
|
7,200
|
|
$53,600
|
The computer is expected to be obsolete in three years, at which time its salvage value is expected to be $20,000. The company follows the practice of treating salvage value as inflow at the time that it is likely to be received.
1. Compute the savings in annual cash expenses after taxes. Assume a 50 percent tax rate.
2. Decide whether or not to purchase the computer, using the net present value method. Assume a minimum rate of return of 10 percent after taxes.