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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 will be $ 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 the operating cost will be $30,000 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 35%. Cash flows have been forecasted in real terms. The real cost of capital is 12%. Which machine should united Automation sell? Explain the assumption underlying your answer?
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