Problem

On January 1, 199X, the management of Sport Shoes Incorporated (SSI) discusses whether they should keep the shoe-making machinery they bought three years ago or replace it with new automated machinery. The present system has a market price of $300,000. Its original price was $500,000, and it was depreciated using the straight-line method (no salvage value and a five-year assumed life). Its market price at the end of the first year (December 31, 199X) is estimated to be reduced to $220,000 and reduces by $20,000 each year up to the end of the third year and by $60,000 each year after that. The income from the sale of the products of the present system for the next four years is $200,000/year and is reducing by $50,000 every year thereafter. The total expense for each year is $70,000. The new system, if bought, will have a purchase price of $500,000 using the same depreciation method as the old system. The income from its operations will be $280,000 each year. The first-year total expense is $100,000 increasing by $10,000 every year. The estimated resale value of this system at the end of the first year is $350,000, dropping by $50,000 each year. The MARR for SSI is 8%, and their tax rate is 25%. Analyze this replacement problem for a planning horizon of one to five years and recommend a decision to the management of SSI.