Beryl\'s Iced Tea currently rents a bottling machine for $52,000 per year, inclu

Question

Beryl's Iced Tea currently rents a bottling machine for $52,000 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 $160,000. This machine will require $22,000 per year in ongoing maintenance expenses.

B. Purchase a new, more advanced machine for $255,000. This machine will require $16,000 per year in ongoing maintenance expenses and will lower bottling costs by $15,000 per year. Also, $37,000 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 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.

Explanation / Answer

In the given question we have to compute the NPV of the FCF associated with each alternative.

We should select the alternative having the Highest NPV Between two options.

The below spreadsheet showing the computation of NPV

Hence NPV lower in the case of exising machine therefore purchase the current machine having lower NPV          ($ 231211)

0 1 2 3 4 5 6 7 8 9 10 Rent Machine 1. Rent ($52000) ($52000) ($52000) ($52000) ($52000) ($52000) ($52000) ($52000) ($52000) ($52000) 2. FCF ($36400) ($36400) ($36400) ($36400) ($36400) ($36400) ($36400) ($36400) ($36400) ($36400) 3. NPV@7% ($255658) Purchase Current Machine 1. Maintenance ($22000) ($22000) ($22000) ($22000) ($22000) ($22000) ($22000) ($22000) ($22000) ($22000) 2. Depreciation $22857 $22857 $22857 $22857 $22857 $22857 $22857      - - - 3. Capital Expenditure ($160000) 4. FCF ($160000) ($8543) ($8543) ($8543) ($8543) ($8543) ($8543) ($8543) ($15400) ($15400) ($15400) 5. NPV@7% ($231211) Purchase Advanced Machine 1. Maintenance ($16000) ($16000) ($16000) ($16000) ($16000) ($16000) ($16000) ($16000) ($16000) ($16000) 2. Other costs ($37000) $15000 $15000 $15000 $15000 $15000 $15000 $15000 $15000 $15000 $15000 3. Depreciation $36429 $36429 $36429 $36429 $36429 $36429 $36429    -           -          - 4. Capital Expenditure ($255000) 5. FCF ($280900) $10229 $10229 $10229 $10229 $10229 $10229 $10229 ($700) ($700) ($700) 6. NPV@7% ($337178)

Related Questions

Navigate

• Browse (All)
• Browse B
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.