Beryl\'s Iced Tea currently rents a bottling machine for $54,000 per? year, incl

Question

Beryl's Iced Tea currently rents a bottling machine for

$54,000

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

$165,000.

This machine will require

$22,000

per year in ongoing maintenance expenses.

B. Purchase a? new, more advanced machine for

$260,000.

This machine will require

$20,000

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

$12,000

per year.? Also,

$39,000

will be spent upfront training 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 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

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

Explanation / Answer

Solution:

Discount Rate 7.00% Tax Rate 30.00% Year 0 1 2 3 4 5 6 7 8 9 10 Rent Machine Rent (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) (54,000.00) FCF(rent) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) (37,800.00) NPV (265,491.38) Purchase Current Machine Maintenance (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) (22,000.00) Depreciation 23,571.43 23,571.43 23,571.43 23,571.43 23,571.43 23,571.43 23,571.43 Capital Expenditures (165,000.00) FCF(purchase current) (165,000.00) (8,328.57) (8,328.57) (8,328.57) (8,328.57) (8,328.57) (8,328.57) (8,328.57) (15,400.00) (15,400.00) (15,400.00) NPV (235,053.18) Purchase Advanced Machine Maintenance (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) (20,000.00) Other Costs (39,000.00) 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 12,000.00 Depreciation 37,142.86 37,142.86 37,142.86 37,142.86 37,142.86 37,142.86 37,142.86 Capital Expenditures (260,000.00) FCF(purchase advanced) (287,300.00) 5,542.86 5,542.86 5,542.86 5,542.86 5,542.86 5,542.86 5,542.86 (5,600.00) (5,600.00) (5,600.00) NPV (266,579.97) Decision: Purchase Current Machine

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