Beryl\'s Iced Tea currently rents a bottling machine for $50,000 per year, inclu
ID: 2779918 • Letter: B
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 $165,000. This machine will require $20,000 per year in ongoing maintenance expenses.
b. Purchase a new, more advanced machine for $250,000. This machine will require $18,000 per year in ongoing maintenance expenses and will lower bottling costs by $10,000 per year. Also, $37,000 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 $208574. (Round to the nearest dollar.)
The NPV of purchasing the current machine is -$______ (Round to the nearest dollar.)
The NPV of purchasing the advanced machine is -$_____. (Round to the nearest dollar.)
Please show the easiest way to complete this problem while including all steps (using a financial calculator, or an equation). Please do not fill out a chart with PV's for the 10 years. Thank you.
Explanation / Answer
Beryl's Iced Tea If Machine is Renting Year 0 1 2 3 4 5 6 7 8 9 10 Rent -50000 -50000 -50000 -50000 -50000 -50000 -50000 -50000 -50000 -50000 Tax 17500 17500 17500 17500 17500 17500 17500 17500 17500 17500 FCF(Rent)=(Rent+Tax)= (-$50000+$17500) -32500 -32500 -32500 -32500 -32500 -32500 -32500 -32500 -32500 -32500 P.V factor @9% for 10 years 0.917 0.842 0.772 0.708 0.65 0.596 0.547 0.502 0.46 0.422 P.V $ (29,803) $ (27,365) $ (25,090) $ (23,010) $ (21,125) $ (19,370) $ (17,778) $ (16,315) $ (14,950) $ (13,715) NPv=(Total of all PV) $ (208,520) a) Purchase Machine Year 0 1 2 3 4 5 6 7 8 9 10 Capital Expenditure $ (165,000.00) Maintenance $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) $ (20,000) Depreciation=($165000/7) $ (23,571) $ (23,571) $ (23,571) $ (23,571) $ (23,571) $ (23,571) $ (23,571) Tax =-(-20000-23571)*35% $ 15,250 $ 15,250 $ 15,250 $ 15,250 $ 15,250 $ 15,250 $ 15,250 $ 7,000 $ 7,000 $ 7,000 Expenses after tax $ (28,321) $ (28,321) $ (28,321) $ (28,321) $ (28,321) $ (28,321) $ (28,321) $ (13,000) $ (13,000) $ (13,000) Add: Dep $ 23,571 23571 23571 23571 23571 23571 23571 FCF $ (165,000.00) $ (4,750) $ (4,750) $ (4,750) $ (4,750) $ (4,750) $ (4,750) $ (4,750) $ (13,000) $ (13,000) $ (13,000) P.V Factor 9% for 10 years 1 0.917 0.842 0.772 0.708 0.65 0.596 0.547 0.502 0.46 0.422 P.V=(FCF* PV factor) $ (165,000.00) $ (4,355.89) $ (3,999.86) $ (3,667.33) $ (3,363.30) $ (3,087.78) $ (2,831.26) $ (2,598.48) $ (6,526.00) $ (5,980.00) $ (5,486.00) NPV= $ (206,895.90) b) a) Purchase Machine Year 0 1 2 3 4 5 6 7 8 9 10 Capital Expenditure $ (250,000.00) Maintenance $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) $ (18,000) Other Cost $ (37,000.00) $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 $ 10,000 Depreciation=($250000/7) $ (35,714) $ (35,714) $ (35,714) $ (35,714) $ (35,714) $ (35,714) $ (35,714) Tax =-(-18000+10000-35714)*35% $ 12,950.00 $ 14,250 $ 14,250 $ 14,250 $ 14,250 $ 14,250 $ 14,250 $ 14,250 $ 2,800 $ 2,800 $ 2,800 Expenses after tax $ (29,464) $ (29,464) $ (29,464) $ (29,464) $ (29,464) $ (29,464) $ (29,464) $ (5,200) $ (5,200) $ (5,200) Add: Dep $ 35,714 23571 23571 23571 23571 23571 23571 FCF $ (274,050.00) $ 6,250 $ (5,893) $ (5,893) $ (5,893) $ (5,893) $ (5,893) $ (5,893) $ (5,200) $ (5,200) $ (5,200) P.V Factor 9% for 10 years 1 0.917 0.842 0.772 0.708 0.65 0.596 0.547 0.502 0.46 0.422 P.V=(FCF* PV factor) $ (274,050.00) $ 5,730.90 $ (4,962.15) $ (4,549.62) $ (4,172.45) $ (3,830.64) $ (3,512.40) $ (3,223.63) $ (2,610.40) $ (2,392.00) $ (2,194.40) NPV= $ (299,766.77)
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