B10. (Replacement cycles) Suppose Daimler Chrysler is considering which of two emission testing devices to buy. Machine A costs $100,000, has a five-year useful life, and has operating expenses of $40,000 per year. Machine B costs $36,000, has a six-year useful life, and has operating expenses of $62,000 per year. Both machines will have zero salvage value, revenues of $85,000 per year, and straight-line depreciation to a zero book value, and both will be replaced at the end of their lives. Daimler Chrysler’s tax rate is 35%.
a. Assume a 12% cost of capital for each machine. Which one should Daimler Chrysler buy?
b. Suppose instead that machine A requires a higher cost of capital, 15%, because it’s a riskier process. Machine B’s cost of capital is still 12%. Which machine should Daimler Chrysler buy?
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