Barney Manufacturing Co. produces personal fitness machines. The once successful line is no longer selling well, so
Question:
Barney Manufacturing Co. produces personal fitness machines. The once successful line is no longer selling well, so the company is considering production of a new improved cardio-vascular machine. This can be done by buying needed production equipment. There is a six-month manufacturing, delivery, setup, and training delay before the equipment will be ready for production. The company wants to start producing the new cardio machine in January next year. Two options are available – lease or buy.
Buy Option – The entire purchase price of the production equipment is $600K and is due at the time of the order. The cost of capital for this purchase is 10%. Assume there are no taxes.
Lease Option – A $25K deposit is due at the time of the order. The remaining portion of the first year’s lease payment ($160K) is due in January next year. The other three annual lease payments ($185K each) are due in January of production years 2, 3, and 4. The cost of capital for leasing is also 10%.
Revenue from sales of the new cardiovascular machines is expected to be:
• Year 1 - $380,000
• Year 2 – $260,000
• Year 3 – $145,000
• Year 4 – $80,000
Calculate the net present value of both the new purchase option and the lease option. Show all work. Determine the best option for Barney, and justify your answer.
Introduction to Operations Research
ISBN: 978-1259162985
10th edition
Authors: Frederick S. Hillier, Gerald J. Lieberman