THE CNC MACHINE DECISION
When the CNC machine broke down, it was a wake-up call for French. The production line was dependent on both CNC machines working full timeâ€”if they slowed down or needed repair, the business suffered. French believed the key to relieving this bottleneck would be increasing capacity. It not only would prevent downtime but also would allow the company to take on new business. 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 companyâ€™s margins on the additional revenues were expected to be 35%. French saw two viable options to increase capacity: 1. Purchase an additional CNC machine for cash, or 2. Finance the purchase of an additional CNC machine 1 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 Although it would be costly, the idea of adding a third CNC machine appealed to French. It would provide him peace of mind that if there were a breakdown, jobs would continue on schedule. Frenchâ€™s preliminary research revealed that the cost of the new equipment would be $142,000. He also estimated that there would be increased out-ofpocket 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. The company had the necessary cash on hand to make the down payment for the lease. With both the leasing and purchasing options, the company had sufficient space to operate the new equipment, and French believed he had almost all of the right employees in place to execute this plan.