Question

Big Rock Brewery currently rents a bottling machine for

$54,000

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

$160,000​,

which will require

$20,000

per year in ongoing maintenance​ expenses, or option​ b, which is to purchase a​ new, more advanced machine for

$250,000​,

which will require

$20,000

per year in ongoing maintenance expenses and will lower bottling costs by

$13,000

per year.​ Also,

$37,000

will be spent upfront in training the new operators of the machine. Suppose the appropriate discount rate is

8%

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

35%.

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

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