Question

Ellison Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor's punch press is substantially identical and each has a useful life of 20 years. In addition. Engineering has estimated that required year-end maintenance costs will be $1,000 per year for the first 5 years, $2,000 per year for the next 10 years, and $3,000 per year for the last 5 years. Following Is each vendor's sales package. Vendor A: $55,000 cash at time of delivery and 10 year-end payments of $18,000 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000. Vendor B: Forty semiannual payments of $9, 500 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge. Vendor C: Full cash price of $150,000 will be due upon delivery.

Answer 1

Solution:

Determining that from which Vendor the Press Should be Purchased:

Vendor: A

Payment	$18,000
(PV of ordinary annuity 10%, 10 periods)	*6.14457
	$110,602.26
Add: Down Payment	$55,000
Maintenance contract	$10,000
Total Cost From Vendor A	$175,602.26

Vendor: B

Semiannual Payment	$9,500
(PV of annuity due 5%, 40 periods)	*18.01704
Total Cost From Vendor B	$171,161.88

Vendor: C

Maintenance Costs for 5 years	$1,000
(PV of ordinary annuity of 5 periods, 10%)	*3.79079
PV of first 5 years of Maintenance	$3,790.79

Maintenance Costs for 10 years	$2,000
[PV of ordinary annuity 15 per., 10%(7.60608) - PV of ordinary annuity 5 per., 10%(3.79079)]	*3.81529
PV of next 10 years of Maintenance	$7,630.58

Maintenance Costs for last 5 years	$3,000
[(PV of ordinary annuity 20 per., 10%(8.51356) - PV of ordinary annuity 15 per., 10%(7.60608)]	*0.90748
PV of last 5 years of Maintenance	$2,722.44

Total Costs of Press and Maintenance Vendor C is as follows:

Cash Purchase Price	$150,000
Maintenance years 1 - 5	$3,790.79
Maintenance years 6 - 15	$7,630.58
Maintenance years 16 - 20	$2,722.44
Total Cost From Vendor C	$164,143.81

Comparing the Total Costs from Three Vendors, the Press should be purchased for Vendor C. Because the Present Value of the cash outflows for Vendor is the lowest of the Three Options.