Question

Riverbed Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process. After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor. The Engineering Department has determined that each vendor’s punch press is substantially identical and each has a useful life of 20 years. In addition, Engineering has estimated that required year-end maintenance costs will be $940 per year for the first 5 years, $1,940 per year for the next 10 years, and $2,940 per year for the last 5 years. Following is each vendor’s sales package.

Vendor A: $53,000 cash at time of delivery and 10 year-end payments of $17,520 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $10,000.

Vendor B: Forty semiannual payments of $8,980 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge.

Vendor C: Full cash price of $164,000 will be due upon delivery.

Assuming that both Vendors A and B will be able to perform the required year-end maintenance, that Riverbed’s cost of funds is 10%, and the machine will be purchased on January 1, compute the following:

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The present value of the cash flows for vendor A. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

The present value of the cash outflows for this option is $

The present value of the cash flows for vendor B. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

The present value of the cash outflows for this option is $

The present value of the cash flows for vendor C. (Round factor values to 5 decimal places, e.g. 1.25124 and final answer to 0 decimal places, e.g. 458,581.)

The present value of the cash outflows for this option is $

Answer 1

We can find out the present value of the cash flows of each vendor in the following manner:

Notes:

1) The initial payment to vendor A includes $10000 towards maintenance service contract.

2) We can use the discounting rate equal to the cost of capital of 10% for vendors A and C as their cash flows occur at the end of year. However, the cash flows for vendor B occur semi-annually, thus, the discount factor of 1.04881 (semi-annual equivalent for discount rate of 10%) is used in the case of vendor B.