Question

Kiddy Toy Corporation needs to acquire the use of a machine to be used in its manufacturing process. The machine needed is manufactured by Lollie Corp. The machine can be used for 10 years and then sold for $30,000 at the end of its useful life. Lollie has presented Kiddy with the following options: (FV of $1, PV of $1, FVA of $1, PVA of $1, FVAD of $1 and PVAD of $1) (Use appropriate factor(s) from the tables provided.)

1. Buy machine. The machine could be purchased for $180,000 in cash. All insurance costs, which approximate $25,000 per year, would be paid by Kiddy.

2. Lease machine. The machine could be leased for a 10-year period for an annual lease payment of $45,000 with the first payment due immediately. All insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lollie at the end of the 10-year period.

Required: Assuming that a 10% interest rate properly reflects the time value of money in this situation and that all maintenance and insurance costs are paid at the end of each year, determine which option Kiddy should choose. Ignore income tax considerations. (Negative amounts should be indicated by a minus sign. Round your final answers to nearest whole dollar amount.)

Answer 1

YEAR	PRESENT VALUE @ 10%
1	.909
2	.826
3	.751
4	.683
5	.601
6	.564
7	.513
8	.467
9	.424
10	.386
TOTAL	6.124

1) PURCHASE MACHINE:-

COST OF MACHINE=$ 180000

COST OF INSURANCE=$ 25000/YEAR PRESENT VALUE FOR 10 YEARS OF 10%=6.124

SALVAGE VALUE(SCRAP VALUE)=$ 30000 PRESENT VALUE AT 10 TH YEAR=.386

SO,

OUTFLOW:

PARTICULAR		AMOUNT($)
COST OF MACHINE		(180000)
COST OF INSURANCE	25000*6.124	(153100)
OUT FLOW		(333100)

INFLOW

SALVAGE VALUE AT 10 TH YEAR=$ 30000*.386=$ 11580

NET CASH FLOW=CASH INFLOW - CASH OUTFLOW

=11580-333100=(321520)

2)LEASE MACHINE:

ANNUAL LEASE PAYMENT =$ 45000

YEAR	P.V @ 10% (A)	(B)	AMOUNT ($) (A)*(B)
1-10*	6.124	(45000)	(275580)
TOTAL OUTFLOW			(275580)

* PAYMENTS ARE ASSUMED TO BE MADE AT THE END OF THE YEAR.

SO,THE NET CASH OUTFLOW OF PURCHASE OF MACHINE=(321520)

NET CASH OUTFLOW OF LEASING OF MACHINE =(275580)

SO, LEASE OPTION CAN CHOOSE ,

IT IS PREFERABLE OF AQUIRE MACHINE ON LEASE WHICH ONLY INCURE AMOUNT= $ 275580

WHICH CAN A BENEFIT OF45940 (321520-275580).