Question

Beryl's Iced Tea currently rents a bottling machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead and is comparing two options: a. Purchase the machine it is currently renting for $155,000. This machine will require $24,000 per year in ongoing maintenance expenses. b. Purchase a new, more advanced machine for $260,000. This machine will require $ 16,000 per year in ongoing maintenance expenses and will lower bottling costs by $12,000 per year. Also, $40,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 7% per year and the machine is purchased today. Maintenance and bottling costs are paid at the end of each year, as is the cost of the rental machine. Assume also that the machines will be depreciated via the straight-line method over seven years and that they have a 10-year life with a negligible salvage value. The marginal corporate tax rate is 35%. Should Beryl's Iced Tea continue to rent, purchase its current machine, or purchase the advanced machine? To make this decision, calculate the NPV of the FCF associated with each alternative. The NPV of renting the current machine is $ . (Round to the nearest dollar.) The NPV of purchasing the current machine is $ . (Round to the nearest dollar.) The NPV of purchasing the advanced machine is $ . (Round to the nearest dollar.)

Answer 1

Rent Machine Rent FCF(rent) = rent * (1-tax) =50000*(1-0.35) x discount factor at 7% OD 1 2 3 4 5 6 7 8 9 10 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 -50,000.00 - 32,500.00 - 32,500.00 -32,500.00 -32,500.00 -32,500.00 -32,500.00 -32,500.00 -32,500.00 -32,500.00 -32,500.00 1.00 0.93458 0.87344 0.81630 0.76290 0.71299 0.66634 0.62275 0.58201 0.54393 0.50835 0.00 -30,373.83 -28,386.76 -26,529.68 -24,794.09 -23,172.05 -21,656.12 -20,239.37 -18,915.30 -17,677.85 -16,521.35 -228266 PV NPV (sum of PV) Purchase Current Machine After tax Maintenance = 24000*(1-0.35) tax shield on Depreciation (155000/7)*0.35 Capital Expenditures FCF(purchase current) 0 1 2 3 4 5 6 7 8 9 10 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 -15,600.00 7,750.00 7,750.00 7,750.00 7,750.00 7,750.00 7,750.00 7,750.00 -155,000.00 -155,000.00 -7,850.00 -7,850.00 -7,850.00 -7,850.00 -7,850.00 -7,850.00 -7,850.00 -15,600.00 -15,600.00 -15,600.00 1.00 0.93458 0.87344 0.81630 0.76290 0.71299 0.66634 0.62275 0.58201 0.54393 0.50835 -155,000.00 -7,336.45 -6,856.49 -6,407.94 -5,988.73 -5,596.94 -5,230.79 -4,888.59 -9,079.34 -8,485.37 -7,930.25 -222801 PV NPV (sum of PV) Purchase Advanced Machine 0 1 2 3 4 5 6 7 8 9 10 After tax Maintenance = 16000*(1-0.35) -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 -10,400.00 (Other Costs)/savings net of tax = 40000*(1-0.35), 12000*(1-0.35) -26,000.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 7,800.00 tax shield on Depreciation (260000/7)*0.35 13,000.00 13,000.00 13,000.00 13,000.00 13,000.00 13,000.00 13,000.00 Capital Expenditures -260,000.00 FCF(purchase advanced) -286,000.00 10,400.00 10,400.00 10,400.00 10,400.00 10,400.00 10,400.00 10,400.00 -2,600.00 -2,600.00 -2,600.00 x discount factor at 7% 1.00 0.93458 0.87344 0.81630 0.76290 0.71299 0.66634 0.62275 0.58201 0.54393 0.50835 PV -286,000.00 9,719.63 9,083.76 8,489.50 7,934.11 7,415.06 6,929.96 6,476.60 -1,513.22 -1,414.23 -1,321.71 NPV (sum of PV) -234201 Decision: Purchase Current Machine (as cost in present terms is lowest) 4 Sheet22 Sheet23 Sheet24 Sheet25 Sheet26 Sheet27 Sheet28 Sheet29 Sheet30 Sheet31_ 1 III e 9 OŠ TU ENG UK 09:32 05/11/2019