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 12 years and then sold for $11,000 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 $161,000 in cash. All maintenance and insurance costs, which approximate $6,000 per year, would be paid by Kiddy.

2.Lease machine. The machine could be leased for a 12-year period for an annual lease payment of $26,000 with the first payment due immediately. All maintenance and insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lollie at the end of the 12-year period.

Required:
Assuming that a 11% 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, find the present value for the following options. Ignore income tax considerations. Determine which option Kiddy should choose. (Negative amounts should be indicated by a minus sign. Round your final answers to nearest whole dollar amount.)

PV

Buy option:

Lease option:

Answer 1

Answer:

	Present value
Buy Option	-196811
Lease Option	-187369

Working notes for the above answer is as under

1

First we will calculate the present value of buy option as under

present value of buy option

= Purchase price + Present value of Annual Expanses - Present value of salvage value

=-161,000 -6000*(PVIFA 12 years,11%) +11,000 *(PVIF 12 th year,11%)

If we look in to the present value annuity table then ,

=PVIFA 12 years,11%

=Present value of an ordinary annuity of $1: n = 12, i = 11%

=6.4924

If we look in to the present value annuity table then ,

(PVIF 12 th year,11%)

=Present value of $1: n = 12, i = 11%

=0.2858

present value of buy option

= Purchase price + Present value of Annual Expanses - Present value of salvage value

=-161,000 -6000*(PVIFA 12 years,11%) +11,000 *(PVIF 12 th year,11%)

=-161,000 -(6000*6.4924) +(11,000 * 0.2858)

=-196810.6

_________________________________________

2

Now we will find the present value of lease option as under

present value of Lease option

= Annual Lease payment x*(PVIFA 12 years,11%)

=-26000*( PVIFA 12 years,11%) )

Present value of an annuity due of $1: n = 12, i = 11%=7.2065

present value of Lease option

= Annual Lease payment x*(PVIFA 12 years,11%)

=-26000*7.2065

=-187,369

	Prasent value
Buy Option	-196811
Lease Option	-187369