ABC Ltd.must decide whether to replace an existing machine. The company do not currently pay taxes. The replacement machine costs $9000 now and requires maintenance of $1000 at the end of every year for eight years. At the end of 8 years the machine would be sold for $2000 (after any taxes). The existing machine requires increasing amounts of maintenance at the end of each year and its salvage value falls each year as shown:

Year Maintenance Cost ($)After-tax Salvage Value

0 0 4,000

1 1,000 2,500

2 2,000 1,500

3 3,000 1,000

4 4,000 0

The existing machine will last 4 more years before it falls apart (i.e. salvage value at the end of year 4 is zero). The company has a required rate of return of 15%.

A. Calculate the present value and equivalent annual cost of the new machine (12 marks).

B. Calculate the cost of keeping the old machine for 1 year and then replacing it (12 marks).

C. Recommend the best course of action for ABC Ltd, explaining your answer (6 marks).