Question

Shamrock 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 $950 per year for the first 5 years, $1,950 per year for the next 10 years, and $2,950 per year for the last 5 years. Following is each vendor’s sales package. Vendor A: $53,020 cash at time of delivery and 10 year-end payments of $16,890 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 $10,500. Vendor B: Forty semiannual payments of $8,730 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 $152,200 will be due upon delivery. Assuming that both Vendors A and B will be able to perform the required year-end maintenance, that Shamrock’s cost of funds is 10%, and the machine will be purchased on January 1, compute the following: The present value of the cash flows for vendor A. The present value of the cash outflows for this option is $ The present value of the cash flows for vendor B. The present value of the cash outflows for this option is $ The present value of the cash flows for vendor C. The present value of the cash outflows for this option is $ From which vendor should the press be purchased? The press should be purchased from?

Answer 1

option 1: purchase from vendor A:( where seperate annual maintanance contract is also purchased)

Statement showing total present value of cash outflows

Particulars	amount $
cash price	53,020
annual service contract fee	10,500
present value of the year end payments for 10 years [16,890 * 6.1444 (cumulative discount factor for 10 years)]	103,778.92
Total cash outflow	167,298.92

option 1: purchase from vendor A:( where seperate annual maintanance contract is not purchased)

Statement showing total present value of cash outflows

Particulars	amount $
cash price	53,020
present value of the year end payments for 10 years [16,890 * 6.1444 (cumulative discount factor for 10 years)]	103,778.92
maintanance cost for first 5 years [950 * 3.7906 (cumulative discount factor for 1 - 5 years)]	3,601.07
maintanance cost for first 5 to 10 years [1950 * 3.8153 (cumulative discount factor for 5 - 10 years)]	7,439.84
maintanance cost for first 10 to 15 years [2950 * 0.9074 (cumulative discount factor for 10 - 15 years)]	2,676.83
Total cash outflow	170,516.66

option 2: purchase from vendor B

Statement showing total present value of cash outflows

Particulars	amount $
first instalment of semi annual payment due upon delivery	8,730
present valu of second instalment of semi annual payment at discounted for year 1 [ 8730 * 0.9090 (discounting factor of year 1)]	7,935.57
balance semi annual instalments of 8730 $ each from year 2 to 20 [8730 * 2 * 7.6043 (cumulative discount factor for 2 - 20 years)]	132,771.08
Total cash outflow	149,436.65

option 3: purchase from vendor C:

Statement showing total present value of cash outflows

Particulars	amount $
cash price	152,200
maintanance cost for first 5 years [950 * 3.7906 (cumulative discount factor for 1 - 5 years)]	3,601.07
maintanance cost for first 5 to 10 years [1950 * 3.8153 (cumulative discount factor for 5 - 10 years)]	7,439.84
maintanance cost for first 10 to 15 years [2950 * 0.9074 (cumulative discount factor for 10 - 15 years)]	2,676.83
Total cash outflow	165,917.74

ANALYSIS: vendor B is the best choice as the total cash outflow is the least compared to vendor A and vendor C.

Statement showing the present value discounting factors at 10%

year	discounting factor @ 10 %
1	0.9090
2	0.8264
3	0.7513
4	0.6830
5	0.6209
6	0.5645
7	0.5132
8	0.4665
9	0.4241
10	0.3855
11	0.3505
12	0.3186
13	0.2897
14	0.2633
15	0.2394
16	0.2176
17	0.1978
18	0.1799
19	0.1635
20	0.1486