Question

raded 0 11 Saved Help Save 1 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 12 years and then sold for $17,000 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 S1) (Use appropriate factor(s) from the tables provided.) 1. Buy machine. The machine could be purchased for $167,000 in cash. All insurance costs, which approximate $12,000 per year, would be paid by Kiddy 2. Lease machine. The machine could be leased for a 12-year period for an annual lease payment of $32,000 with the first payment due immediately. All insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lole at the end of the 12. 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 I Buy option Lease option Kiddy should choose Lease Next 4 of 5 < Prev

Answer 1

Solution

Kiddy Toy

PV $243,345 $239,843 Buy Option Lease Option Kiddy should choose Lease

Computations –

Buy or lease decision –

Buy option –

Determination of present value of cash outflows –

Present value of cost of machine = $167,000 x 1.000 = $167,000

Present value of annual insurance payments for 12 years at 10%,

= $12,000 x (P/A, 10%, 12)

= 12,000 x 6.814 = $81,768

Less: present value of machine’s salvage value = $17,000 x (P/F, 10%, 12)

= 17,000 x 0.319 = $5,423

Present value of cash outflows = 167,000 + 81,768 – 5,423 = $243,345

Lease option –

Present value of annual lease payment = $32,000 x annuity due at 10% for 12 years

= 32,000 x 7.4951 = $239,843

The present value of cash outflows for leasing option = $239,843

On comparison, the present value of cash outflows for lease option, $239,843 is less than the present value of cash outflows for Buy option, $243,345. Hence, the decision is to choose Lease option.