Question

As a result of improvements in product engineering, United Automation is able to sell one of its two milling machines. Both machines perform the same function but differ in age. The newer machine could be sold today for $50,000. Its operating costs are $20,000 a year, but in five years the machine will require a $20,000 overhaul. Thereafter operating costs will be $30,000 until the machine is finally sold in year 10 for $5,000. The older machine could be sold today for $25,000. If it is kept, it will need an immediate $20,000 overhaul. Thereafter operating costs will be $30,000 a year until the machine is finally sold in year 5 for $5,000. Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real terms. The real cost of capital is 12%. Which machine should United Automation sell?

Answer key shows:

PV of cost of new machine=59,492

Equivalent annual cost of selling new machine=16,504

PV of cost of old machine=93,376

Equivalent annual cost of selling old machine=16,526

I tried to solve based on similiar question posted on Chegg but I couldn't find this numbers.

Answer 1

• Hence, alternative 1 has the least Equivalent annual costs
• So it is recommended to select alternative 1 and sell new machine and keep old machine.

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