Question

Hello,

Can you please help me solve this problem and give an explanation for the correct answer? Thank you.

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 15 years and then sold for $20,000 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 $170,000 in cash. All insurance costs, which approximate $15,000 per year, would be paid by Kiddy. 2. Lease machine. The machine could be leased for a 15-year period for an annual lease payment of $35,000 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 15-year period. Required: Assuming that a 12% 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.) Buy option Lease option Kiddy should choose $ $ Lease PV 268,509 266,986

Answer 1

Solution:

AR 9 Computation of Present value of Cash outflows for buy and lease option - Kiddy Toy Corporation Particulars Period Amount PV Factor Present Value Buying Option: Cost of Machine 0 $170,000.00 $170,000.00 Annual maintenance and insurance cost 1-15 $15,000.00 6.810864 $102,162.97 Salvage Value 15 $20,000.00 0.182696 $3,653.93 10 11 12 Present value of cash outflows - Buying option $268,509.04 14 15 Leasing Option: Annual Lease Rent 0-14 $35,000.00 7.628168 $266,985.89 17 18 Present value of cash outflows - Leasing Option $266,985.89 19 20 21 23 26 28 29 30 31 32 33 35 36 37 38 39 41 42 43 44 45 46 47 48 49 50 51 et591 Sheet174 (2) ) Sheet595 ) Sheet596 Sheet174 (5)

Kiddy should choose "lease option" as it has lesser PV of cash outflows.