Beryl\'s Iced Tea currently rents a bottling machine for $53,000 per year, inclu

Question

Beryl's Iced Tea currently rents a bottling machine for $53,000 per year, including all maintenance expenses. It is considering purchasing a machine instead and is comparing two options: Purchase the machine it is currently renting for $155,000. This machine will require $22,000 per year in ongoing maintenance expenses. Purchase a new, more advanced machine for $260,000. This machine will require $17,000 per year in ongoing maintenance expenses and will lower bottling costs by $15,000 per year. Also, $40,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 8% 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 30%. 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

1) Renting the current machine: Annual after-tax cash outflows 37100 (53000*0.7) pvifa(8,10) 6.7101 PV of CFAT 248945 2) Purchase the rented machine: Initial cost: cost of the machine 155000 annual operating costs: years years 1 to 7 8 to 10 maintenance expenses 22000 22000 depreciation (155000/7) 22143 0 total pre-tax expenses 44143 22000 tax shield @ 30% 13243 6600 after tax expenses 30900 15400 less: depreciation 22143 0 yearly cash outflows after tax 8757 15400 pvifa(8,7) 5.2064 pvifa(8,3)*pvif(8,7) 1.5037 (2.5771*0.5835) PV 45593 23158 PV of CFAT - years 1 to 10 68751 initial cost 155000 PV of total outflows 223751 3) Purchase the advanced machine: Initial cost: cost of the machine 260000 cost of training of operators 40000 300000 annual operating costs: years years 1 to 7 8 to 10 maintenance expenses-bottling exp 2000 2000 depreciation (260000/7) 37143 0 total pre-tax expenses 39143 2000 tax shield @ 30% 11743 600 after tax expenses 27400 1400 less: depreciation 37143 0 yearly cash outflows after tax -9743 1400 pvifa(8,7) 5.2064 pvifa(8,3)*pvif(8,7) 1.5037 (2.5771*0.5835) PV -50725 2105 PV of CFAT - years 1 to 10 -48620 PV tax shield on training cost -11111 (40000*0.3/1.08) initial cost 300000 PV of total outflows 240269 Decision: Beryl's Iced Tea should buy the current (rented) machine as the PV of the cash flows for the 10 year life, is lowest for itat $223,751. For renting the PV of outlfows is $248,945 and for buying the advance machine the PV is $240,269.

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