As a result of improvements in 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 5 years the machine will require a $20,000 overhaul. Thereafter, operating costs will be $30,000 until the machine is 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 until the machine is sold in year 5 for $5,000.
Both machines are fully depreciated for tax purposes. The company pays tax at 35%. The cost of capital is 12%. Which machine should United Automation sell? Explain any assumptions underlying your answer.