Question

Sullivan Ironworks offers a variety of iron products to individual and commercial construction clients. The company expects to retire all its production equipment in the new year. At that point, Sullivan Ironworks is considering three options: Option 1) It rents its production equipment at an annual cost of $950,000 per year, paid at the beginning of the year. There are no maintenance costs. Option 2) It rents state-of-the-art production equipment at an annual cost of $1,300,000 per year, paid mid- year. The company will save $325,000 annually on production costs. There are no maintenance costs. Option 3) It purchases new equipment for $9,650,000. The equipment will require maintenance of $150,000 per year and is expected to have a life span of 15 years with no salvage value at the end. Sullivan Ironworks uses the straight-line depreciation method. Suppose the discount rate is 2.9%, the company’s tax rate is 20%, and all maintenance costs are paid at year's end, which is a better option for Sullivan Ironworks?

Answer 1