Machine A has been completely overhauled for$9000 and is expected to last another 12 years. The $9000 was treated as an expense for tax purposes last year. Machine A can be sold now for $30,000 net after selling expenses, but will have no salvage value 12 years hence. It was bought new 9 years ago for $54,000 and has been depreciated since then by straight-line depreciation using a 12-year depreciable life.

Because less output is now required, Machine A can now be replaced with a smaller machine: Machine B costs $42,000, has an anticipated life of 12 years, and would reduce operating costs $2500 per year. It would be depreciated by straight-line depreciation with a 12-year depreciable life and no salvage value. Both the income tax and capital gains tax rates are 40%. Compare the after-tax annual cost of the two machines and decide whether Machine A should be retained or replaced by Machine B. Use a 10% after-tax rate of return in the calculations.