Reference no: EM132696817
ABC Ltd. must decide whether to replace an existing machine. The company do not currently pay taxes. The replacement machine costs $9000 now and requires maintenance of $1000 at the end of every year for eight years. At the end of 8 years the machine would be sold for $2000 (after any taxes).
The existing machine requires increasing amounts of maintenance at the end of each year and its salvage value falls each year as shown:
Year Maintenance Cost ($) After-tax Salvage Value
0,,,,,,, 0,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, 4000
1 ,,,,,,, 1000 ,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,2500
2,,,,,,,, 2000,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,1500
3 ,,,,,,,,3000,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, 1000
4 ,,,,,,,,4000,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,,, 0
The existing machine will last 4 more years before it falls apart (i.e. salvage value at the end of year 4 is zero). The company has a required rate of return of 15%.
Problem A. Calculate the present value and equivalent annual cost of the new machine
Problem B. Calculate the cost of keeping the old machine for 1 year and then replacing it
Problem C. Recommend the best course of action for ABC Ltd, explaining your answer