The NVP renting the machine is $ The NVP of purchasing the current machine is $
ID: 2753009 • Letter: T
Question
The NVP renting the machine is $
The NVP of purchasing the current machine is $
The NVP of purchasing the advanced machine is $
Beryls 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 $160,000. This machine will require $23,000 per year in ongoing maintenance expenses. b. Purchase a new, more advanced machine for $265,000. This machine will require $15,000 per year in ongoing maintenance expenses and will lower bottling costs by $12,000 per year. Also, $39,000 will be spent up front to train the new operators of the machine. Suppose the appropriate discount rate is 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 38% 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 S(Round to the nearest dollar.)Explanation / Answer
Answer: Alternative-1 Rent the machinery Rent = $50,000 per year Evaluation period = 7 years Discount rate = 7% Therefore NPV of this alternative = $269,464.47 Alternative-2 Purchase machine Cost of machine = $160,000 Maintenance cost per year = $23,000 Depreciation on machine for 7 Years = $22,857.14 per year Life of machinery = 10 Years Tax Rate = 38% Discount rate = 7% Year 0 1 2 3 4 5 6 7 Cost of machine $160,000 Depreciation $22,857.14 $22,857.14 $22,857.14 $22,857.14 $22,857.14 $22,857.14 $22,857.14 Depreciation tax shield $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 Cash Flows ($160,000) $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 $8,685.71 NPV of this alternative = ($105,785.21) Alternative-3 Purchase machine Cost of machine = $265,000 Maintenance cost per year = $15,000 Depreciation on machine for 7 Years = $37,857.14 per year Savings = $12,000 per year One time expense = $39,000 Life of machinery = 10 Years Tax Rate = 38% Discount rate = 7% Year 0 1 2 3 4 5 6 7 8 9 10 Cost of machine ($265,000) One time expense ($39,000) Savings $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 $12,000 Amortization ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) ($3,900) Depreciation ($37,857.14) ($37,857.14) ($37,857.14) ($37,857.14) ($37,857.14) ($37,857.14) ($37,857.14) Earning Before Tax ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) $8,100.00 $8,100.00 $8,100.00 Tax (38%) 0 0 0 0 0 0 0 ($3,078.00) ($3,078.00) ($3,078.00) Earning After Tax ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) ($29,757.14) $5,022.00 $5,022.00 $5,022.00 Cashflows ($304,000) $8,100.00 $8,100.00 $8,100.00 $8,100.00 $8,100.00 $8,100.00 $8,100.00 $5,022.00 $5,022.00 $5,022.00 NPV at 7% discount rate = ($252,139.34) So alternative-1 is the best one.