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. EVA of $1. PVA of $1. FVAD of $1 and PVAD of S1) (Use appropriate factor(s) from the tables provided.) 1. Pay $1,050,000 in cash immediately. 2. Pay $441,000 immediately and the remainder in 10 annual installments of $92,000, with the first installment due in one year. 3. Make 10 annual installments of $154,000 with the first payment due immediately. 4. Make one lump-sum payment of $1,710,000 five years from date of purchase. Required: Determine the best alternative for Harding, assuming that Harding can borrow funds at a 10% interest rate. (Round your final answers to nearest whole dollar amount.) PV Option 1 Option 2 Option 3 Option 4 The best alternative for Harding

Answer 1

Option 1

Present value = Cash out flow X PV factor

PV factor will be 1 since, payment is made immediately or at 0 year

=$1,050,000 X 1

=$1,050,000

Option 2

Present value = Cash out flow X PV factor

$441,000 is paid immediately so, PV factor will be 1

and sum of $92,000 will be paid every year starting from year 1 and till 10 years .For this, we will use PVIFA (Cumulative Present value interest factor annuity), 10 years at 10 %

= ($441,000 X 1) + ($92,000 X 6.1446)

=$441,000 + $565,303.2

=$1,006,303.2

=$1,006,303 ( Rounded off)

Option 3

Present value = Cash out flow X PV factor

Here, first payment of $154,000 is paid immediately which means PV factor for this will be 1.

We paid first installment immediately which means 9 installments are left. For 9 installments , we will use PVIFA (Cumulative Present value interest factor annuity), 9 years at 10 %.

=($154,000 X 1) + ($154,000 X 5.7590)

=$154,000 + $886,886

=$1,040,886

Option 4

Present value = Cash out flow X PV factor

Date of purchase year = 0 year

5 years from date of purchase which means 5 th year

Lumpsum amount of $1,710,000 is paid in the 5th year

We will use PV factor for 5th year

=$1,710,000 X 0.62092

=$1,061,773.2

=$1,061,773 ( Rounded off)

Option 2 will be the best alternative as present value of cash outflows is less in this option in comparison to other options