Suppose you have to decide whether sell an old machine or keep it with a major overhaul. You can:
A) Sell the machine at time zero for X dollars with zero book value and paying the tax of 40%.
B) Keep the machine, which requires a major overhaul cost of $1,000,000 at time zero. The overhaul cost is depreciable from time 0 to year 5 (over six years) based on MACRS 5-year life depreciation with the half year convention (table A-1 at IRS (Links to an external site.)Links to an external site.). In this case machine can produce and generate equal annual revenue of 900,000 dollars for five years (year 1 to 5) and salvage value of the machine will be $250,000 with zero book value at the end of year 5. The operating cost of the machine will be $400,000 per year from year 1 to year 5.
Calculate the sale value, X, that can break-even the NPV of keeping the machine. Consider 40% income tax rate and after-tax minimum ROR of 18%.