If capacity increased, French estimated that sales revenues would rise by at least $50,000 per month due to unmet demand and increased efficiency.

The companys margins on the additional revenues were expected to be 35%

. French saw three viable options to increase capacity:

1. Purchase an additional CNC machine for cash,

2. Finance the purchase of an additional CNC machine, or

3. Add a third shift (a night shift) to better utilize the two CNC machines Peregrine already owned. French considered the details of each option, keeping in mind that for long-term projects he would use a discount rate of 7%.

OPTION 1: PURCHASE A NEW CNC MACHINE WITH CASH

Long term projects he would use a discount rate of 7% Frenchs preliminary research revealed that the cost of the new equipment would be $142,000. He also estimated that there would be increased out-of-pocket operating costs of $10,000 per month if a new machine were brought online. After five years, the machine would have a salvage value of $40,000. Although Peregrine did not have the cash readily available to make the purchase, French believed that with a small amount of cash budgeting and planning, this option would be feasible. OPTION 2:

FINANCE THE PURCHASE OF A NEW CNC MACHINE The company selling the CNC machine also offered a leasing option. The terms of the lease included a down payment of $50,000 and monthly payments of $2,200 for five years. After five years, the equipment could be purchased for $1. The operating costs and salvage values would be the same as option 1, the purchasing option.

OPTION 3: ADD A THIRD SHIFT his initial plan was for the night shift to run as a skeleton crew with the primary purpose of keeping the CNC machines operational for 24 hours. He believed that adding a third shift would produce the same increase in revenue as adding a new CNC machine to his existing shifts. He estimated that adding a third shift would create $12,000 in additional monthly out-of-pocket operating costs, but no $ on machinery.

2. Compute and compare the net present value and payback period of each option.

4. Rounding to the nearest 1%, at what discount rate does leasing produce a higher net present value than paying cash?