Question

Big Rock Brewery currently rents a bottling machine for $52,000 per​ year, including all maintenance expenses. The company is considering purchasing a machine instead and is comparing two alternate​ options: option a is to purchase the machine it is currently renting for $155,000​, which will require $22,000 per year in ongoing maintenance​ expenses, or option​ b, which is to purchase a​ new, more advanced machine for $250,000​, which will require $18,000 per year in ongoing maintenance expenses and will lower bottling costs by $10,000 per year.​ Also, $37,000 will be spent upfront in 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 are subject to a CCA rate of 45% and there will be a negligible salvage value in 10​ years' time​ (the end of each​ machine's life). The marginal corporate tax rate is 40%. Should Big Rock Brewery 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

Workings:

Net Present Value of Rental Option = -$219,136

Net Present Value of purchase its Current​ Machine = -$194,127

Net Present Value of purchase the Advanced​ Machine = -$234,286

NPV are ​negative as it represents the present value of the costs of the machine in each​ case. The decision will be basis the lowest cost that will be incurred.

Thus, Net Present Value of purchase its Current​ Machine has the lowest negative NPV and hence it is recommended to purchase its current machine.

Workings: