Question

​Beryl's Iced Tea currently rents a bottling machine for $51,000 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 $160,000. This machine will require $23,000 per year in ongoing maintenance expenses.

b. Purchase a​ new, more advanced machine for $260,000. This machine will require $19,000 per year in ongoing maintenance expenses and will lower bottling costs by $13,000 per year.​ Also, $38,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 7% 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 40%.

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.

Answer 1

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