Edward has invented and patented a unique machine that will allow farmers to increase the yield on corn crops by 10-15%. After having someone make the machines for him for the last three years, his company now has enough market momentum to really grow. From his recent experience, he knows that he can sell the machine for $5,500. His current manufacturer charges him $4,000 to make each machine, but will reduce that price to $3,250 for a five-year contract. After a lot of research, Edward believes, he can produce each machine for $2,750. To produce the machines on his own, he has the option to buy a great facility for $1,250,000 or to lease a facility for $12,000 per month for five years. After looking at how he wants to capitalize his business for the next five years, he forecast that he will finance 40% of it with debt at 6% interest, net of tax. He plans on a 20% return on his equity. For this decision, he is satisfied with a hurdle rate that is 25% more than his cost of capital. Since he is evaluating this decision over a five year operating horizon, he believes he can sell the facility in five years for 10% more than the amount he paid for it. If he forecasts to sell 1,000 machines next year, with the number of units sold growing 5% each year, assuming no change in his selling price or any of the costs he is considering, what should Edward do? Please solve with excel.

EBK CONTEMPORARY FINANCIAL MANAGEMENT

14th Edition

ISBN:9781337514835

Author:MOYER

Publisher:MOYER

Chapter10: Capital Budgeting: Decision Criteria And Real Option

Section: Chapter Questions

Problem 13P

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2. Edward has invented and patented a unique machine that will allow farmers to increase the yield on corn crops by 10-15%. After having someone make the machines for him for the last three years, his company now has enough market momentum to really grow. From his recent experience, he knows that he can sell the machine for $5,500. His current manufacturer charges him $4,000 to make each machine, but will reduce that price to $3,250 for a five-year contract. After a lot of research, Edward believes, he can produce each machine for $2,750. To produce the machines on his own, he has the option to buy a great facility for $1,250,000 or to lease a facility for $12,000 per month for five years. After looking at how he wants to capitalize his business for the next five years, he forecast that he will finance 40% of it with debt at 6% interest, net of tax. He plans on a 20% return on his equity. For this decision, he is satisfied with a hurdle rate that is 25% more than his cost of capital. Since he is evaluating this decision over a five year operating horizon, he believes he can sell the facility in five years for 10% more than the amount he paid for it. If he forecasts to sell 1,000 machines next year, with the number of units sold growing 5% each year, assuming no change in his selling price or any of the costs he is considering, what should Edward do? Please solve with excel.

Group of answer choices

a. In house production in an owned facility

b. Outsourced production

c. Not produce this product

d. In house production in a leased facility

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