Question

Beryl's Iced Tea currently rents a bottling machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead and is comparing two options: a. Purchase the machine it is currently renting for $150,000. This machine will require $22,000 per year in ongoing maintenance expenses. b. Purchase a new, more advanced machine for $255,000. This machine will require $18,000 per year in ongoing maintenance expenses and will lower bottling costs by $10,000 per year. Also, $39,000 will be spent up front to train 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 cost of the rental machine. Assume also that the machines will be depreciated via the straight-line method over seven years and that they have a 10-year life with a negligible salvage value. The marginal corporate tax rate is 38%. Should Beryl's Iced Tea 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.

a. The NPV of renting the current machine is __________?

b. The NPV of purchasing the current machine is ________?

c. The NPV of purchasing the advanced machine is _______?

Answer 1

Option A
NPV of Renting existing machine for 10 Yrs						Amount in $
Particulars	Years
0	1	2	3	4	5	6	7	8	9	10
Rent		50000	50000	50000	50000	50000	50000	50000	50000	50000	50000
Less : Taxes @ 38%		19000	19000	19000	19000	19000	19000	19000	19000	19000	19000
Rent after Tax		31000	31000	31000	31000	31000	31000	31000	31000	31000	31000
PVF @ 8%		0.926	0.857	0.794	0.735	0.681	0.630	0.583	0.540	0.500	0.463
NPV	1	28704	26578	24609	22786	21098	19535	18088	16748	15508	14359	208013
Total cost of renting machine for 10 years is $ 208013

Option B		Dep	150000/7	21429
NPV of Purchasing existing machine
Particulars	Years
0	1	2	3	4	5	6	7	8	9	10
Maintenance		22000	22000	22000	22000	22000	22000	22000	22000	22000	22000
Dep		21429	21429	21429	21429	21429	21429	21429
Maintenance + Dep		43429	43429	43429	43429	43429	43429	43429	22000	22000	22000
Taxes @ 38%		16503	16503	16503	16503	16503	16503	16503	8360	8360	8360
Net Expenditure		26926	26926	26926	26926	26926	26926	26926	13640	13640	13640
Add : Dep		-21429	-21429	-21429	-21429	-21429	-21429	-21429	0	0	0
Cash flow after Dep		5497	5497	5497	5497	5497	5497	5497	13640	13640	13640
Capital Expenditure	150000
PVF @ 8%	1	0.926	0.857	0.794	0.735	0.681	0.630	0.583	0.540	0.500	0.463
NPV	150000	5090	4713	4364	4041	3741	3464	3208	7369	6823	6318	199131
NPV of Purchasing existing machine is $ 199131

Option C		Dep	255000/7	36429
NPV of Purchasing Advanced machine
Particulars	Years
0	1	2	3	4	5	6	7	8	9	10
Maintenance		18000	18000	18000	18000	18000	18000	18000	18000	18000	18000
Dep		36429	36429	36429	36429	36429	36429	36429
Lower Bottling Cost		-10000	-10000	-10000	-10000	-10000	-10000	-10000	-10000	-10000	-10000
Total Expenditure		44429	44429	44429	44429	44429	44429	44429	8000	8000	8000
Taxes @ 38%		16883	16883	16883	16883	16883	16883	16883	3040	3040	3040
Net Expenditure		27546	27546	27546	27546	27546	27546	27546	4960	4960	4960
Add : Dep		-36429	-36429	-36429	-36429	-36429	-36429	-36429	0	0	0
Cash flow after Dep		-8883	-8883	-8883	-8883	-8883	-8883	-8883	4960	4960	4960
Capital Expenditure	255000
Traning	39000
PVF @ 8%	1	0.926	0.857	0.794	0.735	0.681	0.630	0.583	0.540	0.500	0.463
NPV	255000	-8225	-7616	-7051	-6529	-6046	-5598	-5183	2680	2481	2297	216211
NPV of Purchasing Advanced machine is $ 216211
Conclusion
From the above three options
It is clearly evident that Option B is economical i.e. purchasing the exisiting machine since its NPV is lower than the other two options