Majestic, Inc. is a very profitable store in Houston, which is contemplating the replacement of a fully depreciated existing machine it had purchased…

Majestic, Inc. is a very profitable store in Houston, which is contemplating the replacement of a fully depreciated existing machine it had purchased for $22,500 five years ago. The replacement machine costs $37,500 and requires maintenance of $1,500 at the end of every year for ten years. The salvage/resale value of the new machine will be $7,500 at the end of 10 years. Once the old machine is replaced by the new machine, Majestic, Inc. expects to replace the new machine by a similar machine every ten years for the foreseeable future. The existing machine however requires increasing amounts of maintenance each year, and its salvage (or resale) value falls. If sold today (t = 0) it will fetch $8,250; if sold one year from now (at t = 1) it will fetch $6,000, if sold at t = 2, $2,250 and it will be worthless after three years (at t = 3). But at the same time, the maintenance costs will go up with every year the machine is retained: $2,250 in year 1, $6,000 in year 2 and $7,500 in year 3. For simplicity assume that maintenance costs are paid at the end of the year and ignore taxes for now.

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