Question

Beryl's Iced Tea currently rents a bottling machine for $ 52 comma 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 comma 000. This machine will require $ 21 comma 000 per year in ongoing maintenance expenses.

b. Purchase a​ new, more advanced machine for $ 255 comma 000. This machine will require $ 20 comma 000 per year in ongoing maintenance expenses and will lower bottling costs by $ 14 comma 000 per year.​ Also, $ 37 comma 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 35 %.

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

Alternative 1: Rent the Machine

The same with Excel formulas shown:

Alternative 2: Purchase the same Machine

The same with Excel formulas shown:

Alternative 3: Purchase Advanced Machine

The same with Excel formulas shown:

Purchasing the same machine is the best alternative since it has the lowest NPV of costs