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Commercial Hydronics is considering replacing one of its larger control devices. A new unit sells for $29,000 (delivered). An additional $3,000 will be needed to install the device. The new device has an estimated 20-year service life. The estimated salvage value at the end of 20 years will be $2,000. The new control device will be depreciated over 20 years on a straight-line basis to $0. The existing control device (original cost = $15,000) has been in use for 12 years, and it has been fully depreciated (that is, its book value equals zero). Its scrap value is estimated to be $1,000. The existing device could be used indefinitely, assuming the firm is willing to pay for its very high maintenance costs. The firm’s marginal tax rate is 40 %. The new control device requires lower maintenance costs and frees up personnel who normally would have to monitor the system. Estimated annual cash savings from the new device will be $9,000. The firm’s cost of capital is 12 %. Using this information, evaluate the relative merits of replacing the old control device using the net present value approach. Compute the annual depreciation and the net cash flows.
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