Question

Beryl's Iced Tea currently rents a bottling machine for

$ 55 comma 000$55,000

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 comma 000$155,000.

This machine will require

$ 21 comma 000$21,000

per year in ongoing maintenance expenses.

B. Purchase a​ new, more advanced machine for

$ 260 comma 000$260,000.

This machine will require

$ 15 comma 000$15,000

per year in ongoing maintenance expenses and will lower bottling costs by

$ 10 comma 000$10,000

per year.​ Also,

$ 39 comma 000$39,000

will be spent upfront training the new operators of the machine.

Suppose the appropriate discount rate is

7 %7%

per year and the machine is purchased today. Maintenance and bottling costs are paid at the end of each​ year, as is the rental of the machine. Assume also that the machines will be depreciated via the​ straight-line method over seven years and that they have a​ ten-year life with a negligible salvage value. The marginal corporate tax rate is

35 %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.​ (Note: the NPV will be​ negative, and represents the PV of the costs of the machine in each​ case.)

Answer 1

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