Problem: 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 are $20,000 per year, but in five years the machine will require a $20,000 overhaul. Thereafter operating costs will be $30,000 per year 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 operating costs will be $30,000 a year until the machine is finally sold in year 5 for $5,000. To keep the problem relatively straightforward, you can ignore taxes. Cash flows have been forecasted in real terms. The real cost of capital is 12 percent. Assume that whenever the machines have to be replaced, they will be replaced with a machine that will be as efficient to operate as the newer machine that you currently have.
Which machine should United Automation sell? Show the calculations backing your answer. [Hint: use the equivalent annual cost method]