Question

Ellison 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 \(1,000 per year for the first 5 years, \)2,000 per year for the next 10 years, and \(3,000 per year for the last 5 years. Following is each vendor’s sales package.

Vendor A: \)55,000 cash at time of delivery and 10 year-end payments of \(18,000 each. Vendor A offers all its customers the right to purchase at the time of sale a separate 20-year maintenance service contract, under which Vendor A will perform all year-end maintenance at a one-time initial cost of \)10,000.

Vendor B: Forty semiannual payments of \(9,500 each, with the first installment due upon delivery. Vendor B will perform all year-end maintenance for the next 20 years at no extra charge.

Vendor C: Full cash price of \)150,000 will be due upon delivery.

Instructions Assuming that both Vendors A and B will be able to perform the required year-end maintenance, Ellison’s cost of funds is 10%, and the machine will be purchased on January 1, from which vendor should the press be purchased?

Short answer

The best option will be to purchase from Vendor C.

Step-by-step solution

Computation of Vendor A

Payment	18,000
(PV of ordinary annuity 10%, 10 periods)	6.14457
	110,602.26
Add: Down payment	55,000
Maintenance Contract	10,000
Total cost from vendor A	175,602.26

Computation of Vendor B

Semi-annual Payment	9,500
PV of an annuity due 5%, 40 periods	18.01704
Total cost	171,161.88

Computation of Vendor C

PV of first 5 years of maintenance	1,000*3.79079	3,790.79
PV of next 10 years of maintenance	2,000*3.81529	7,630.58
PV of last 5 years of maintenance	3,000*0.90748	2,722.44
Cash purchase price		150,000
Total cost from vendor C		164,143.81

The machine should be purchased from Vendor C.