Question

2. Candy Cotton Ice-cream House currently rents an ice-cream machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead, and is comparing two options:

1. Purchase the machine it is currently renting for $150,000. This machine will require $20,000 per year in ongoing maintenance expense.
2. Purchase a new more advanced machine for $250,000. This machine will require $15,000 per year in ongoing maintenance expense and lower annual packaging costs by $10,000. Additionally, the machine will require an upfront expense of $35,000 for training of operators.

Suppose the appropriate discount rate is 8% per year and the machine is purchased today. Maintenance and packaging costs are paid at the end of each year, but the rental of the machine is paid at the beginning of the year. Assume also that the machines will be depreciated via the straight-line to zero method over seven years and that they have a 10-year life with no salvage value. The marginal corporate tax rate is 35%. Should Candy Cotton Ice-cream House continue to rent, purchase its current machine, or purchase the advanced machine?

Answer 1

6850 OPTION 1 RETING THE MACHINE 6851 Calculatinof the present value of the renting of themachine for 10 years 6852 years 6853 6854 6855 6856 6857 6858 6859 6860 6861 pv factor present value rent 1.00 50,000.00 0.93 46,296.30 0.86 42,866.94 0.79 39,691.61 0.74 36,751.49 0.68 34,029.16 0.63 31,508.48 0.58 29,174.52 0.54 27,013.44 0.50 25,012.45 0 50,000.00 1 50,000.00 2 50,000.00 3 50,000.00 4 50,000.00 5 50,000.00 6 50,000.00 7 50,000.00 8 50,000.00 9 50,000.00 0.00 10 6864 present value fo the renting the machine 6865 6866 Option 2 buying themachiner @150000 362,344.40 after tax present value main. 6868 years 6869 6870 6871 6872 6873 6874 6875 6876 dep. tax benfit Cost maint. Cost total cost pv factor of cost cost -150,000.00 5,092.59 -4,715.36 -4,366.08 -4,042.66 3,743.21 3,465.93 3,209.20 7,023.50 -6,503.24 -6,021.52 0 -150,000.00 150,000.00 21,428.57 21,428.57 21,428.57 21,428.57 21,428.57 21,428.57 21,428.57 7500 -20,000.00 -13,000.00 5,500.00 0.93 7500 -20,000.00 -13,000.00 5,500.00 0.86 7500 -20,000.00 -13,000.00 5,500.00 0.79 7500 -20,000.00 -13,000.00 5,500.00 0.74 7500 -20,000.00 -13,000.00 5,500.00 0.68 7500 -20,000.00 -13,000.00 5,500.00 0.63 7500 -20,000.00 -13,000.00 5,500.00 0.58 20,000.00 13,000.00 13,000.00 0.54 20,000.00 13,000.00 13,000.00 0.50 20,000.00 13,000.00 13,000.00 0.46 6878 6879 6880 6881 10 total cost of buying the first machine -198,183.28

16883 16884 Option 3 buying themachiner "250000 16885 main. Cost & packing present value 16886 years 16887 16888 16889 16890 16891 16892 16893 16894 16895 16896 16897 16898 16899 16900 16901 comment= net of maintence cost and reducing packing benefit is taken combined in Column E 16902 i.e maintenance cost-benefit of reducing pakcing cost 16903 16904 from comparing the above we find the renting cost is 362334 16905 buying first machine cost is 198183 16906 and buying second machine cost is 241728 16907 16908 therefor first machine buying should be prefer dep. tax benfit cost after tax total cost pv factor of cost cost 0 -285,000.00 285,000.00 3,250.00 9,250.00 0.93 3,250.00 9,250.00 0.86 3,250.00 9,250.00 0.79 3,250.00 9,250.00 0.74 3,250.00 9,250.00 0.68 3,250.00 9,250.00 0.63 3,250.00 9,250.00 0.58 3,250.00 3,250.00 0.54 3,250.00 3,250.00 0.50 3,250.00 3,250.00 0.46 285,000.00 8,564.81 7,930.38 7,342.95 6,799.03 6,295.39 5,829.07 5,397.29 1,755.87 -1,625.81 -1,505.38 35,714.29 35,714.29 35,714.29 35,714.29 35,714.29 35,714.29 35,714.29 12500 5,000.00 12500 5,000.00 12500 5,000.00 12500 5,000.00 12500 5,000.00 12500 5,000.00 12500 5,000.00 5,000.00 5,000.00 5,000.00 10 total cost of buying the first machine 241,728.14

16850 OPTION 1 16851 Calculatii 16852 years rent 16853 0 pv factor present value -+C16853 B16853 -+C16854 B16854 -+C16855 B16855 C16853/1.08 C16854/1.08 50000+C16855/1.08 -c16856/1.08 -+C16857/1.08 -+C16858/1.08 -+C16859/1.08 C16860/1.08 6856-816856 168574 -c16857. B 16857 -+C16858 B16858 +C16859*B16859 -+C16860 B16860 -+C16861 B16861 16859 6 50000 68/1086862 B168652 804- -SUM(D16853:D16863) 16866 Option 2 b after tax maint. Cost present value of cost -+G16869 H16869 16868 years cost tax benfit Cost total cost dep =+816869+D16869«F16869 1 20000 E16870 (1-0.35) +B16870+D16870+F16870 +H16869/1.08 +G16870 H16870 -20000 2-E16871"(1-0.35):+816871+D16871+F168712-H16870/1.08:+G16871"H16871 20000 --E16872"(1-0. 35) =+816872+D16872+F16872 H16871/1.08 =+G16872"H16872 20000 --E16873"(1-0. 35) =+B16873+D16872+F16873 H16872/1.08 =+G16873"H16873 -20000 16874 (1-0.35)+B16874+D16874+F16874 +H16873/1.08+G16874 H16874 20000 --E16875"(1-0. 35) =+816875+D16875+F16875 H16874/1.08 =+G16875"H16875 20000-北16876"(1-0.35)計B16876+D16876+F16876 +H16875/1.08 =+G16876"H16876 20000 E16877(1-0.35) +B16877+D16877+F16877 +H16876/1.08G16877 H16877 20000 --E16878"(1-0. 35) =+816878+D168784F 16878 H16877/1.08 =+G16878"H16878 20000 E16879*(1-0.35)B16879+D16879+F16879 H16878/1.08+G16879 H16879 -+C16870 0.35 -c16871"0.35 -+C16872 0.35 -+C16873 0.35 -+C16874 0.35 -+C16875 0.35 -+C16876 0.35 16873 4 16874 5 16875 6 16878 9 16879 10O total cost of buying the -SUM(116869:11688

6884 Option 3 6885 main. Cost & packing present value of cost tax benfit 6886 years 6887 0 6888 1 6889 2 6890 3 6891 4 6892 5 6893 6 6894 7 6895 8 6896 9 6897 10 6898 6899 dep after tax total cost -+816887+D16887+F16887 1 pv factor cost -250000-350 +G16887 H16887 --(15000-10000)+E16888 (1-0.35)+816888+D16888+F16888+H16887/1.08+G16888 H16888 --(15000-10000)+E16889*(1-0.35)+816889+D16889+F16889+H16888/1.08 +G16889 H16889 -(15000-10000)E16890*(1-0.35)+816890+D16890+F16890+H16889/1.08 +G16890 H16890 -(15000-10000)E16891 (1-0.35)+816891+D16891+F16891 +H16890/1.08 +G16891 H16891 --(15000-10000)+E16892 (1-0.35)+816892+D16892+F16892+H16891/1.08 G16892 H16892 --(15000-10000) +E16893 (1-0.35)+B16893+D16893+F16893 +H16892/1.08 G16893 H16893 -(15000-10000) +E16894 (1-0.35) +B16894+D16894+F16894 +H16893/1.08 G16894 H16894 a-(15000-10000) .«E16895"(1-0.35) ·+816895+D16895+F16895-+H16894/1.08 s+G16895"H16895 -(15000-10000)+E16896 (1-0.35)+816896+D16896+F16896+H16895/1.08G16896 H16896 (15000-10000)+E16897 (1-0.35)+B16897+D16897+F16897+H16896/1.08G16897 H16897 -+C16888 0.35 -+C16889 0.35 +C16890 0.35 +C16891 0.35 +C16892 0.35 +C16893 0.35 +C16894 0.35 250000/7 total cost of buying the #SUMI 116887:116898) 6901 comment 6902 i.e maint 6904 from com 6905 buying fir 6906 and buyir 6908 therefor f
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