y led Tea currently rents a botting machine for $54,000 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 $150,000. This machine will require $20,000 per year in ongoing maintenance expenses Purchase a new, more advanced machine for $255,000. This machine will require $20,000 per year in ongoing maintenance expenses and will lower botting costs by $13,000 per year. Also, 40,000 will be spent upfront training 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 rental of the machine. Assumen so that the machines will be depreciated via the straight line method over seven years and that they have a ten-year life with a negligible salvage value. The marginal corporate tax rate is 35%. Should Beryl's Iced Tea continue to rent, purchase its cument machine, or purchase the advanced machine? To make this decision, calculate the NPV of the FCF associated with each ternative. (Note: the NPV will be negative, and represents the PV of the costs of the machine in each case) The NPV of renting the machine is $(Round to the nearest dollar Enter a negative NPV as a negative value)
y led Tea currently rents a botting machine for $54,000 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 $150,000. This machine will require $20,000 per year in ongoing maintenance expenses Purchase a new, more advanced machine for $255,000. This machine will require $20,000 per year in ongoing maintenance expenses and will lower botting costs by $13,000 per year. Also, 40,000 will be spent upfront training 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 rental of the machine. Assumen so that the machines will be depreciated via the straight line method over seven years and that they have a ten-year life with a negligible salvage value. The marginal corporate tax rate is 35%. Should Beryl's Iced Tea continue to rent, purchase its cument machine, or purchase the advanced machine? To make this decision, calculate the NPV of the FCF associated with each ternative. (Note: the NPV will be negative, and represents the PV of the costs of the machine in each case) The NPV of renting the machine is $(Round to the nearest dollar Enter a negative NPV as a negative value)
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
Section: Chapter Questions
Problem 1PS
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Question
![**Option Evaluation for Berry's Iced Tea Bottling Machine**
Berry's Iced Tea currently rents a bottling machine for $55,000 per year, including all maintenance expenses. The company is considering purchasing a machine instead and is evaluating two options:
**Option A: Purchase Existing Machine**
- Current cost: $155,000
- Ongoing maintenance expenses: $20,000 per year
**Option B: Purchase Advanced Machine**
- Cost: $255,000
- Ongoing maintenance expenses: $20,000 per year
- Bottling costs savings: $13,000 per year
- Additional upfront training costs: $40,000
### Financial Considerations:
- **Maintenance and Bottling Costs:** Paid at the end of each year.
- **Depreciation:** Straight-line method over seven years with negligible salvage value.
- **Marginal Corporate Tax Rate:** 35%
- **Discount Rate:** 7% per year on the machine.
### Decision-Making Process:
To make an informed decision between renting, purchasing the current machine, or purchasing the advanced machine, calculate the Net Present Value (NPV) of Free Cash Flows (FCF) associated with each alternative. Note that NPV may be negative, which must be considered in the evaluation.
### NPV Calculation:
Follow these steps to determine NPV for each alternative:
1. **Calculate the FCF for each year.** This involves considering initial costs, ongoing maintenance, bottling cost savings, and any upfront costs like training.
2. **Apply Tax Implications.** Adjust FCF by considering the 35% corporate tax rate.
3. **Discount FCF to Present Value.** Use the 7% discount rate to find the present value of each year’s FCF.
4. **Sum these Present Values.** The total gives the NPV for the investment.
### Example Calculation:
**The NPV of renting the machine is:**
\[ NPV = \$ \boxed{-} \]
(Round to the nearest dollar and enter a negative NPV as a negative value.)
After careful consideration, this NPV will guide Berry’s Iced Tea in choosing the best financial option to optimize operations and cost efficiency.](/v2/_next/image?url=https%3A%2F%2Fcontent.bartleby.com%2Fqna-images%2Fquestion%2F7eb16600-8f07-40f7-854e-83024f28a747%2F408365ca-bb8a-420f-9972-18f4d96c4c8e%2Fhz9jusa_processed.jpeg&w=3840&q=75)
Transcribed Image Text:**Option Evaluation for Berry's Iced Tea Bottling Machine**
Berry's Iced Tea currently rents a bottling machine for $55,000 per year, including all maintenance expenses. The company is considering purchasing a machine instead and is evaluating two options:
**Option A: Purchase Existing Machine**
- Current cost: $155,000
- Ongoing maintenance expenses: $20,000 per year
**Option B: Purchase Advanced Machine**
- Cost: $255,000
- Ongoing maintenance expenses: $20,000 per year
- Bottling costs savings: $13,000 per year
- Additional upfront training costs: $40,000
### Financial Considerations:
- **Maintenance and Bottling Costs:** Paid at the end of each year.
- **Depreciation:** Straight-line method over seven years with negligible salvage value.
- **Marginal Corporate Tax Rate:** 35%
- **Discount Rate:** 7% per year on the machine.
### Decision-Making Process:
To make an informed decision between renting, purchasing the current machine, or purchasing the advanced machine, calculate the Net Present Value (NPV) of Free Cash Flows (FCF) associated with each alternative. Note that NPV may be negative, which must be considered in the evaluation.
### NPV Calculation:
Follow these steps to determine NPV for each alternative:
1. **Calculate the FCF for each year.** This involves considering initial costs, ongoing maintenance, bottling cost savings, and any upfront costs like training.
2. **Apply Tax Implications.** Adjust FCF by considering the 35% corporate tax rate.
3. **Discount FCF to Present Value.** Use the 7% discount rate to find the present value of each year’s FCF.
4. **Sum these Present Values.** The total gives the NPV for the investment.
### Example Calculation:
**The NPV of renting the machine is:**
\[ NPV = \$ \boxed{-} \]
(Round to the nearest dollar and enter a negative NPV as a negative value.)
After careful consideration, this NPV will guide Berry’s Iced Tea in choosing the best financial option to optimize operations and cost efficiency.
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