Valuation fundamentals Nelson wants to increase the production capacity of his cattle food plant in Pretoria, South Africa. He is trying to evaluate the economics of purchasing a pelleting machine that is suitable for his requirements. The supplier has offered two alternatives. Nelson can either buy the machine upfront or lease it for a fixed annual payment over four years. If he buys the machine upfront, he will need to spend an additional $6,000 a year on spare parts and maintenance and can sell it for $125,000 at the end of four years. If he leases the machine, it will cost him $10,000 per year and all maintenance cost will be borne by the supplier. If Nelson buys the machine, he will use money he has saved and invested earning a 4% annual return. Assume that all the cash flows occur at the end of each year.

a. Draw a timeline showing the cash flows, their timing, and the required return applicable to finding the net present cost.

b. What is the maximum price Nelson should pay for this machinery? Explain with the help of values calculated in part a.