30. Mutually exclusive investments and project lives (S6.4) 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 a year, but at the end of five years, the machine will require a $20,000 overhaul (which is tax deductible). Thereafter, operating costs will be

$30,000 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 (tax-deductible) overhaul.

Thereafter, operating costs will be $30,000 a year until the machine is finally sold in year 5 for $5,000. Both machines are fully depreciated for tax purposes. The company pays tax at 21%. Cash flows have been forecasted in real terms. The real cost of capital is 12%. Which machine should United Automation sell? Explain the assumptions underlying your answer.

Chapter 6 Making Investment Decisions with the Net Present Value Rule 179