Question:
You have been negotiating with a customer for several months over the purchase of a very expensive automatic filling and packaging system. The purchase price of your machine is $1,000,000 plus $20,000 installation and training costs. It is expected that your machine will reduce the packaging cost of your customer's operation by $100,000 per year, that the machine will have a life of 10 years, and can be resold at the end of the period for $550,000.
Your competitor has presented a similar system which has a purchase price of $1,100,000, free installation costs, an annual reduction of the packaging cost of your customer's operation of $108,000 per year, and can be resold for $550,000. Your competitor has argued that his higher initial price is justified by the $8,000/month higher savings, which then makes his net price comparable to yours.
Neither you nor your competitor is offering financing, but your customer can borrow from his bank at prime rate, which was recently 5.5% - or pay cash for the equipment at time of purchase.
Your customer has asked you to prepare a financial comparison of the two proposals, and has indicated that he would make his decision on that basis, as the systems are nearly identical.
1. Arrange all of the cash inflows and outflows by proposal by year
2. Calculate the sums of the cash inflows and outflows for each project
3. Calculate the PV (DCF) for each project
4. Calculate the NPV for each project
5. Identify the best solution for your customer