Question content area top

Part 1

Beryl's Iced Tea

currently rents a bottling machine for

$52,000

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

$23,000

per year in ongoing maintenance expenses.

b. Purchase a new, more advanced machine for

$265,000.

This machine will require

$20,000

per year in ongoing maintenance expenses and will lower bottling costs by

$14,000

per year. Also,

$35,000

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

28%.

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.