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 $150,000. This machine will require $24.000 per year in ongoing maintenance expenses. b. Purchase a new, more advanced machine for $265,000. This machine will require $18,000 per year in ongoing maintenance expenses and will lower bottling costs by $10.000 per year. Also, $38,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 9% 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 30%. 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)

Answer 1

Option 1- Continue to rent

NPV of after-tax cost of renting the bottling machine

-50000*(1-30%)*6.41766=

-224618

(P/A,i=9%;n=10 yrs.=6.41766)

Option 2-Purchase its current machine

NPV of the option=

Initial purchase cost-PV of after-tax maintenance exp. For 10 yrs.+PV of st.line depn.tax shields for 7 yrs.

-150000-(24000*(1-30%)*6.41766)+(150000/7*30%*5.03295)=

-225462

(P/A,i=9%;n=10 yrs.=6.41766)

(P/A,i=9%;n=7 yrs.=5.03295)

Option 3-Purchase an advanced machine

NPV of the option=

Initial cost incl.spl.training)-PV of after-tax maint. Exp.for 10 yrs.+PV of after-tax savings in Bottling costs for 10 yrs.+PV of st.line depn.tax shields for 7 yrs.

-(265000+38000)-(18000*(1-30%)*6.41766)+(10000*(1-30%)*6.41766)+(265000/7*30%*5.03295)=

-281779

ANSWER:

Beryl's should continue to rent the machine --as its NPV of costs is the LOWEST.

NPV of renting the current machine= $ 224618

NPV of the option to
Continue to rent	-224618
purchase the above m/c	-225462
purchase an advanced m/c	-281779