Reference no: EM132700637

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                                            4,000
1                      1,000                                             2,500
2                        2,000                                          1,500
3                        3,000                                         1,000
4                            4,000                                         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%.

Question A. Calculate the present value and equivalent annual cost of the new machine

Question B. Calculate the cost of keeping the old machine for 1 year and then replacing it

Question C. Recommend the best course of action for ABC Ltd, explaining your answer