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 $22,000 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 $172,000 in cash. All insurance costs, which approximate $17,000 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 $37,000 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 10- 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, 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.) PV Buy option Lease option Kiddy should choose

Answer 1

Buy option = $ 267,956

Lease option = $250,046

Kiddy should choose Lease option as outflow is less.

Working note:

In case of buy option, depreciation is ignored as it is non-cash item.

Buy option:

Period	Outflow	PV @10%	PV
0	172000	1	172000
1	17000	0.909	15453
2	17000	0.826	14042
3	17000	0.751	12767
4	17000	0.683	11611
5	17000	0.621	10557
6	17000	0.564	9588
7	17000	0.513	8721
8	17000	0.467	7939
9	17000	0.424	7208
10	17000	0.386	6562
			276448
Less: Residual Value	22000	0.386	8492
Total outflows			267956

Lease option:

Period	Outflow	PV @10%	PV
0	37000	1	37000
1	37000	0.909	33633
2	37000	0.826	30562
3	37000	0.751	27787
4	37000	0.683	25271
5	37000	0.621	22977
6	37000	0.564	20868
7	37000	0.513	18981
8	37000	0.467	17279
9	37000	0.424	15688
Total outflows			250046