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A company currently rents a bottling machine for $50,000 per year, comprising all maintenance expenses. It is considering purchasing the machine instead, and is comparing two options:

1) Buy the machine it is at present renting for $150,000. This machine will need $20,000 per year in ongoing maintenance expenses.

2) Buy a new, more advanced machine for $250,000. This machine will need $15,000 per year in ongoing maintenance expenses and will lower bottling costs by $10,000 per year. In addition, $35,000 will be spent up front in training new operators of the machine.

Assume the suitable discount rate is 8% per year and machine is purchased today. Maintenance and bottling costs are paid at the end of each year, as is the rental of the machine. Suppose also that the machines will be depreciated using the straight-line method over seven years and that they have a ten-year life with a negligible salvage value. Marginal corporate tax rate is 35%. Should company continue to rent, purchase its present machine, or purchase advanced machine?

Accounting Basics, Accounting

  • Category:- Accounting Basics
  • Reference No.:- M910139

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