Answer Happy

Gordon Inc. has a number of copiers that were bought four yearsago for $20,000. Currently maintenance costs $2,000 a year, but themaintenance agreement expires at the end of two years andthereafter the annual maintenance charge will rise to $8,000. Themachines have a current resale value of $8,000, but at the end ofyear 2 their value will have fallen to $3,500. By the end of year 6the machines will be valueless and would be scrapped. Gordon isconsidering replacing the copiers with new machines that would doessentially the same job. These machines cost $25,000, and thecompany can take out an eight-year maintenance contract for $1,000a year. The machines have no value by the end of the eight yearsand would be scrapped. Both machines are depreciated by usingseven-year MACRS, and the tax rate is 35 percent. Assume forsimplicity that the inflation rate is zero. The real cost ofcapital is 7 percent. When should Gordon replace its copiers, now,the end of year 2, or the end of year 6?