Beryl\'s Iced Tea currently rents a bottling machine for $50,000 per year, inclu

Question

Beryl'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. Purchase the machine it is currently renting for $155,000. This machine will require $21,000 per year in ongoing maintenance expenses. b. Purchase a new, more advanced machine for $265,000 This machine will require $18,000 per year in ongoing maintenance expenses and will lower bottling costs by $13,000 per year. Also, $39,000 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 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. The NPV of renting the current machine is (Round to the nearest dollar

Explanation / Answer

Option 1

Option b

NPV of renting the machine=50000*6.42=321000

As the cash flow is lower in option A i.e. purchase the current machine, this option should be preferred as the NPV is 250837 outflow

Initial outflow 155000 1 (155000) Maintenance Expenses for 10 years 21000 6.42 (134820) Savings in cash due to depreciation 155000/7*35%= 5.03 38983 Net Cash Outflow (250837) 1

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