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 8 years and then sold for $12,000 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 $162,000 in cash. All maintenance and insurance costs, which approximate $7,000 per year, would be paid by Kiddy.

2.Lease machine. The machine could be leased for a 8-year period for an annual lease payment of $27,000 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 8-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, find the present value for the following options. Ignore income tax considerations. Determine which option Kiddy should choose.

Answer 1

Buying option

CF0 = -162000

CF1 = -7000 (maintenance cost)

CF2 = -7000 (maintenance cost)

CF3 = -7000 (maintenance cost)

CF4 = -7000 (maintenance cost)

CF5 = -7000 (maintenance cost)

CF6 = -7000 (maintenance cost)

CF7 = -7000 (maintenance cost)

CF8 = 5000 (sale price of machine - maintenance cost)

Now, Press NPV button

I/Y = 10%

NPV is calculated to be -$193,746

Leasing option

CF0 = -27000 (lease payment)

CF1 = -27000 (lease payment)

CF2 = -27000 (lease payment)

CF3 = -27000 (lease payment)

CF4 = -27000 (lease payment)

CF5 = -27000 (lease payment)

CF6 = -27000 (lease payment)

CF7 = -27000 (lease payment)

Now, Press NPV button

I/Y = 10%

NPV is calculated to be -$158,447

The leasing option should be chosen as it results in a lower present cost