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Surface Co. uses a road-paving machine that is currently four years old and has remaining useful life of three years. The machine has become old and inefficient, therefore Surface is considering buying a pre-owned, newer version of the machine. If Surface purchases the newer machine, they can sell the old machine immediately for $90,000. The old machine has been fully depreciated for tax purposes. The newer machine will cost $300,000 and can be used for three years at which point it can be sold for $20,000. The new machine will cut paving costs by $90,000 every year but will cost $10,000 more each year to maintain than the old machine (assume cash flows (and savings) happen at the end of the year). The IRS will allow Surface to deduct depreciation expense on the new machine at $100,000 per year over the next three years. The tax rate is 30% and Surface's cost of capital is 8% (compounded annually).
Problem 1: Should Surface buy the new machine? Why or why not? Show calculations.
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