Flounder Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for...

Question:

Flounder Inc., a manufacturer of steel school lockers, plans to purchase a new punch press for use in its manufacturing process.

After contacting the appropriate vendors, the purchasing department received differing terms and options from each vendor.

The Engineering Department has determined that each vendor's punch press is substantially identical and each has a useful life of 20 years.

In addition, Engineering has estimated that required year-end maintenance costs will be $930 per year for the first 5 years, $1,930 per year for the next 10 years and $2,930 per year for the last 5 years.

Following are each vendor's sales package:

Vendor A:
a) $55,100 cash at time of delivery and 10 year-end payments of $16,290 each.
b) Vendor A offers all its customers the right to purchase, at the time of sale, a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of $9,010.

Vendor B:
a) Forty semi-annual payments of $10,100 each, with the first installment due upon delivery.
b) Vendor B will perform all year-end maintenance for the next 20 years at no extra charge.

Vendor C:
a) Full cash price of $158,600 will be due upon delivery.

Required:

Assume that both Vendors A and B will be able to perform the required year-end maintenance, that Flounder's cost of funds is 10% and the machine will be purchased on January 1.

Round factor values to 5 decimal places and final answer to 0 decimal places.

Compute the following:

1. The present value of the cash flows for vendor A.

2. The present value of the cash flows for vendor B.

3. The present value of the cash flows for vendor C.

4. From which vendor should the press be purchased?

Net Present Value:

Net Present Value will be calculated on the basis of the cash inflow minus cash outflow. When the cash inflow is higher and the NPV is positive in that case the project should be accepted.

Answer and Explanation:

1. Vendor A
For First year = 60060 + 9500 maintenance cost contract = 69560
Year Cash flow Discount Factor @ 10% Present Value
0 69560 1 69,560.00
1 18850 0.90909 17,136.36
2 18850 0.82645 15,578.51
3 18850 0.75131 14,162.28
4 18850 0.68301 12,874.80
5 18850 0.62092 11,704.37
6 18850 0.56447 10,640.33
7 18850 0.51316 9,673.03
8 18850 0.46651 8,793.66
9 18850 0.4241 7,994.24
10 18850 0.38554 7,267.49
11 0.35049 -
12 0.31863 -
13 0.28966 -
14 0.26333 -
15 0.23939 -
16 0.21763 -
17 0.19784 -
18 0.17986 -
19 0.16351 -
20 0.14864 -
Present value of payment for vendor A $185,385.09
2. Vendor B
Interest rate per semi annual = 10% /2= 5% and Number of period = 20 * 2 semia nnual period per year = 40
Year Cash flow Discount Factor @ 5% Present Value
0 10280 1 10,280.00
1 10280 0.95238 9,790.48
2 10280 0.90703 9,324.26
3 10280 0.86384 8,880.25
4 10280 0.8227 8,457.38
5 10280 0.78353 8,054.65
6 10280 0.74622 7,671.09
7 10280 0.71068 7,305.80
8 10280 0.67684 6,957.91
9 10280 0.64461 6,626.58
10 10280 0.61391 6,311.03
11 10280 0.58468 6,010.50
12 10280 0.55684 5,724.29
13 10280 0.53032 5,451.70
14 10280 0.50507 5,192.10
15 10280 0.48102 4,944.86
16 10280 0.45811 4,709.39
17 10280 0.4363 4,485.13
18 10280 0.41552 4,271.55
19 10280 0.39573 4,068.15
20 10280 0.37689 3,874.42
21 10280 0.35894 3,689.93
22 10280 0.34185 3,514.22
23 10280 0.32557 3,346.87
24 10280 0.31007 3,187.50
25 10280 0.2953 3,035.71
26 10280 0.28124 2,891.15
27 10280 0.26785 2,753.48
28 10280 0.25509 2,622.36
29 10280 0.24295 2,497.49
30 10280 0.23138 2,378.56
31 10280 0.22036 2,265.30
32 10280 0.20987 2,157.42
33 10280 0.19987 2,054.69
34 10280 0.19035 1,956.85
35 10280 0.18129 1,863.66
36 10280 0.17266 1,774.92
37 10280 0.16444 1,690.40
38 10280 0.15661 1,609.90
39 10280 0.14915 1,533.24
40 0.14205 -
Present value of payment for vendor B $185,215.18
3. Vendor C
Payment of machine and year-end maintenance costs separetely incurred by Tamarisk Inc.
Year Cash flow Discount Factor @ 10% Present Value
0 159600 1 159,600.00
1 1100 0.90909 1,000.00
2 1100 0.82645 909.09
3 1100 0.75131 826.45
4 1100 0.68301 751.31
5 1100 0.62092 683.01
6 2100 0.56447 1,185.40
7 2100 0.51316 1,077.63
8 2100 0.46651 979.67
9 2100 0.4241 890.60
10 2100 0.38554 809.64
11 2100 0.35049 736.04
12 2100 0.31863 669.12
13 2100 0.28966 608.30
14 2100 0.26333 553.00
15 2100 0.23939 502.72
16 3100 0.21763 674.65
17 3100 0.19784 613.32
18 3100 0.17986 557.56
19 3100 0.16351 506.87
20 3100 0.14864 460.80
Present value of payment for vendor C $174,595.18
Present value for Vendor A $185,385.09
Present value for Vendor B $185,215.18
Present value for Vendor C $174,595.18
Vendor C should be selected. Because of the lowest cash outflow.
4. Machine will be purchased from vendor C.


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