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 $19,000 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 $169,000 in cash. All maintenance and insurance costs, which approximate $14,000 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 $34,000 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 10-year period.

Required: Assuming that a 8% 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.

	PV
Buy Option	$
Lease Option	$
Kiddy Should Choose

Answer 1

Buy Option
Year	cash flow	PVF @ 8%	Present Value
0	169000	1	1,69,000
1	14000	0.9259	12,963
2	14000	0.8573	12,003
3	14000	0.7938	11,114
4	14000	0.7350	10,290
5	14000	0.6806	9,528
6	14000	0.6302	8,822
7	14000	0.5835	8,169
8	14000	0.5403	7,564
9	14000	0.5002	7,003
10*	5000	0.4632	2,316
Present value of cash flow (outflow)			2,58,772
* $19000 Salvage Value- 14000 Expense=$5000

Lease Option
Year	cash flow	PVF @ 8%	Present Value
0	34000	1	34,000
1	34000	0.9259	31,481
2	34000	0.8573	29,150
3	34000	0.7938	26,990
4	34000	0.7350	24,991
5	34000	0.6806	23,140
6	34000	0.6302	21,426
7	34000	0.5835	19,839
8	34000	0.5403	18,369
9	34000	0.5002	17,008
10		0.4632	-
present value of cash flow (outflow)			2,46,394

kiddy should choose Lease option because present value of cash outflow is as compare to buy options