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 $155,000. 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 $17,000 per year in ongoing maintenance expenses and will lower bottling costs by $15,000 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 corporate tax rate is 20%. 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.

Answer 1