You are in charge of procuring a machine for your factory. The process will take about a year to complete and is a major investment in specialized equipment that will make or break the profitability of the company. It is expected the equipment will offer a 7 year advantage after which it will need to be replaced. There is a choice of the manufacturer of the equipment.
Manufacturer A will provide their model with a capacity of 1,000 widgets per year guarantee, and the equipment will require maintenance for 2 weeks each year. The procurement cost will be $1 million in Korea. The delivery costs from Korea to the US factory will be $95,000. Total costs will be $10 per widget and the revenue will be $25 per widget.
The competitor Manufacturer B offers a model from Germany at a cost of $1.2 million, with a delivery cost to the US factory of $100,000 and a capacity of 1,150 widgets per year. The total costs for operation will be $9 per widget, and the machine will require maintenance every 2 years for 2 weeks.
The demand for the widgets is expected to be 1,000 widgets per year for years one to three inclusive, and thereafter at 1,100 widgets per year for the remainder of the lifetime of the equipment. Maintenance cost will be $10,000 per week for Manufacturer A and $9,000 per week for Manufacturer B. The revenue and costs will escalate by 4% per year over the lifetime of the machine, as will the maintenance costs. The first maintenance cost is the expected value and escalation occurs after this first maintenance.
Complete a TCO analysis for these two machines. Show the NCF and the NPV for each of the machines. Questions:
Which machine would be purchased if the decision is made solely on price?
What is the NCF for each Machine?
What is the NPV for each machine if the discount factor is 15%?
Which of these machines should the company purchase based on a TCO analysis?
Is the investment value to the company worth undertaking if the WACC for the company is 13%?