Beryl\'s Iced Tea currently rents a bottling machine for $55,000 per year, inclu

Question

Beryl's Iced Tea currently rents a bottling machine for $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 $165,000. This machine will require $23,000 per year in ongoing maintenance expenses.

B. Purchase a new, more advanced machine for $260,000. This machine will require $17,000 per year in ongoing maintenance expenses and will lower bottling costs by $11,000 per year. Also, $38,000 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 7 years and that they have a 10 year life with a negligible salvage value. The marginal corporate tax rate is 38%.

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

For Option A : (All Amount in $)

For Option B:

From the above calculation Beryl's Iced Tea should go for Advanced machine due to resulted in positive cashflow.

Year CashFlow Depreciation( straight line method Tax 38% CF with Depn and Tax Discounted Rate @7 % Future Cashflow 0 (165,000) (165,000) 1 141,428.57 23571.43 62,700 86,271.43 0.935 80,663.79 2 117,857.14 23571.43 53,742.86 77,314.29 0.873 67,495.38 3 94,285.71 23571.43 44,785.71 68,357.14 0.816 55,779.43 4 70,714.28 23571.43 35,828.57 59,400 0.763 45,322.2 5 47,142.85 23571.43 26,871.43 50,442.86 0.713 35,965.76 6 23,571.43 23571.43 17,914.28 41,485.71 0.666 27,629.48 7 0 23571.43 8,957.14 32,528.57 0.623 20,265.30 Total 168,121.34 Less : Maintenance Cost (10 Year) 230,000 Profit/Loss (61,878.66)

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