Question

Corp10 is buying custom-built machinery with a contract purchase price of $943,420. The manufacturer has offered the company a payment plan that would require five annual beginning-of-year payments of $200,000 each.

a. If the company accepts the offer, what will be the total amount of interest expense it will incur over the five-year life of the loan?

b. If the company can buy the machinery outright by obtaining outside financing elsewhere at 2%, should it do or should it accept the manufacturer’s offer instead? Explain briefly?

Answer 1

a. Interest Amount = Instalments * period - Purchase price

= 200000*5 - 943420

= 1,000,000 - 943420 = $ 56,580

b. Computation of interest rate in the above instalment mothod = (943420 - 200000) / 200000 = 3.7171 is the annuity factor at 4 years time(since instalments are peiad at the beginning of the period, the count of period would be 1 less)

Using the PVIFA table, 3.7171 factor at 4 years is at the discount rate of 3%.

The interest rate offered by outside financing is 2%, which is less than the interest rate charged by the supplier.

Hence, the company should buy the machine outright by obtaining outside financ at 2%