Q2b. Knives Out Co. is considering when to replace its old machine. The company faces 2 options: (1) replace the old machine now, or (2) replace it at the end of six years. Currently, the old machine has a salvage value of $3 million and a book value of $1.5 million. If the machine is not sold, it will require maintenance costs of $775,000 over the next six years at the end of the year. The depreciation expense for the machine is $300,000 per year. At the end of six years, the machine will have a salvage value of only $100,000 and a book value of $0.

If the company replaces the old machine now, the new machine will cost $4.8 million and will require maintenance costs of $320,000 at the end of each year during its economic life of six years. At the end of six years, the new machine will have a salvage value of $900,000. It will be fully depreciated by the straight-line method.

If Knives out to replace the old machine in six years, a replacement machine will cost $3.4 million. The company will need to purchase this machine regardless of its choice today. The corporate tax rate is 21% and the appropriate discount rate is 7.5%. The company is assumed to earn sufficient revenues to generate tax shields from depreciation. Should Knives Out Co. replace the old machine now or at the end of six years?