Question

Beryl's Iced Tea currently rents a bottling machine for $52,000 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 $250,000. This machine will require $16,000 per year in ongoing maintenance expenses and will lower bottling costs by $10,000 per year. Also, $37,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 9% 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 30%. 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

Answer:  Beryl's should purchase its current machine --as its NPV of costs is the LOWEST

B - Purchase of Current Machine with $ -216477 NPV

• NPV of the Options of :

a) Renting the current machine= $ - 233602.82

b) Purchase its Current Machine = $ - 216477

c) Purchase an Advanced Machine = $ - 256794

• Below are the various Calculations:

A) Renting of Current Machine:

NPV of after-tax cost of renting the bottling machine

=> -52,000*(1-30%)*6.41766

=> $ -233,602.82

were (P/A , i=9%; n=10 yrs.=6.41766)

B) Purchase of Current Macine:

NPV = -Initial purchase cost - PV of after-tax maintenance expenses for 10 years. + PV of straight line depreciation tax shields for 7 years

=> -150000 - (22000*(1-30%)*6.41766) + (150000/7 *30% *5.03295)

.=> $ -216477.28

were (P/A , i=9%; n=10 yrs.=6.41766) & (P/A ,i=9%;n=7 yrs.=5.03295)

C) Purchase of New Advanced Macine:

NPV = Initial cost including special training) - PV of after-tax maintenance expense for 10 years + PV of after-tax savings in Bottling costs for 10 years.+ PV of straight line depreciation tax shields for 7 years

=> -(250000+37000) - (16000*(1-30%)*6.41766) + (10000*(1-30%)*6.41766) + (250000/7*30%*5.03295

=> $ -260030

were (P/A , i=9%; n=10 yrs.=6.41766) & (P/A ,i=9%;n=7 yrs.=5.03295)