Question

Harding Company is in the process of purchasing several large pieces of equipment from Danning Machine Corporation. Several financing alternatives have been offered by Danning: ((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. Pay $1,150,000 in cash immediately.
2.Pay $460,000 immediately and the remainder in 12 annual installments of $80,000, with the first installment due in one year.
3. Make 12 annual installments of $135,000 with the first payment due immediately.
4. Make one lump-sum payment of $1,630,000 five years from date of purchase.

Required:
Determine the best alternative for Harding, assuming that Harding can borrow funds at a 7% interest rate. (Round your final answers to nearest whole dollar amount.)

Answer 1

We will evaluate all the alternatives in terms of their present value of cash outflow at year 0 i.e. Now

Discounting rate for that purpose will be 7% (The rate at which Harding can borrow funds)

Alternative 1: Pay $1,150,000 in cash immediately.

Present value will be $ 1,150,000 only.

Alternative 2: Pay $460,000 immediately and the remainder in 12 annual installments of $80,000, with the first installment due in one year.

Year	Cash Outflow	PVIF	PV of Cash Outflows
0	4,60,000	1.0000	4,60,000
1	80,000	0.9346	74,766
2	80,000	0.8734	69,875
3	80,000	0.8163	65,304
4	80,000	0.7629	61,032
5	80,000	0.7130	57,039
6	80,000	0.6663	53,307
7	80,000	0.6227	49,820
8	80,000	0.5820	46,561
9	80,000	0.5439	43,515
10	80,000	0.5083	40,668
11	80,000	0.4751	38,007
12	80,000	0.4440	35,521
Total			10,95,415

Alternative 3: Make 12 annual installments of $135,000 with the first payment due immediately.

Year	Cash Outflow	PVIF	PV of Cash Outflows
0	1,35,000	1.0000	1,35,000
1	1,35,000	0.9346	1,26,168
2	1,35,000	0.8734	1,17,914
3	1,35,000	0.8163	1,10,200
4	1,35,000	0.7629	1,02,991
5	1,35,000	0.7130	96,253
6	1,35,000	0.6663	89,956
7	1,35,000	0.6227	84,071
8	1,35,000	0.5820	78,571
9	1,35,000	0.5439	73,431
10	1,35,000	0.5083	68,627
11	1,35,000	0.4751	64,138
Total			11,47,321

Alternative 4: Make one lump-sum payment of $1,630,000 five years from date of purchase.

PV = 1,630,000 / (1.07)^5 = 1,630,000 / 1.40255 = 1,162,167

Conclusion: The most beneficial alternative will be alternative 2 which is to pay $460,000 immediately and the remainder in 12 annual installments of $80,000, with the first installment due in one year where the present value is $ 1,095,415.