Question

Beef'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. Purchasing the machine it is currently renting for $160,000. This machine will require $25,000 per year in ongoing maintenance expenses.

b. Purchase a new more advanced machine for $255,000. This machine will require $20,000 per year maintening expenses and will lower bottling costs by $15,000 per year. Also, $35,000 will be spent upfront 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 machine will be depreciated via the straight method over 7 years and that they have a 10 year-life with a negligible salvage value. The marginal corporate tax rate is 30%

Should Beef''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