Question

2. Candy Cotton Ice-cream House currently rents an ice-cream machine for $50,000 per year, including all maintenance expenses. It is considering purchasing a machine instead, and is comparing two options:

1. Purchase the machine it is currently renting for $150,000. This machine will require $20,000 per year in ongoing maintenance expense.
2. Purchase a new more advanced machine for $250,000. This machine will require $15,000 per year in ongoing maintenance expense and lower annual packaging costs by $10,000. Additionally, the machine will require an upfront expense of $35,000 for training of operators.

Suppose the appropriate discount rate is 8% per year and the machine is purchased today. Maintenance and packaging costs are paid at the end of each year, but the rental of the machine is paid at the beginning of the year. Assume also that the machines will be depreciated via the straight-line to zero method over seven years and that they have a 10-year life with no salvage value. The marginal corporate tax rate is 35%. Should Candy Cotton Ice-cream House continue to rent, purchase its current machine, or purchase the advanced machine?

Answer 1