Question

The management of The Alexandrov Company decided to acquire the use of a machine to be used in its manufacturing process. The machine is manufactured only by Chang, Incorporated and would have a useful life of ten years. Chang’s management has presented Alexandrov with the following acquisition options:

Lease: The machine could be leased for an eight-year period for an annual lease payment of $60,000, with the first payment due on the date that the agreement is signed. Related annual executory costs (maintenance and insurance expenses for the machine), which are expected to be about $5,000 per year, would be paid by Alexandrov.

Purchase: The machine could be purchased for $375,000 in cash.

Assume that (1) Alexandrov and Chang will agree on a transaction on November 30, 2020; and (2) the current interest rate for Alexandrov’s lease arrangements is 9%, but the rate applicable to annual maintenance and insurance expenses is only 6%.

Using the accompanying Time Value of Money tables, prepare a schedule showing the alternatives available to Alexandrov for the acquisition of the machine.

Answer 1

;Cash Price of Machine : $3,75,000

Present Value of Cash Flows under Lease : $3,94,889

Workings:

Present Value of Lease Payments
Year	Net Cash Flows	PV Factor @ 9%	Present Value
1	$60,000	1.0000	$60,000.00
2	$60,000	0.9174	$55,045.87
3	$60,000	0.8417	$50,500.80
4	$60,000	0.7722	$46,331.01
5	$60,000	0.7084	$42,505.51
6	$60,000	0.6499	$38,995.88
7	$60,000	0.5963	$35,776.04
8	$60,000	0.5470	$32,822.05
Net Present Value (A)	$361,977.17
Present Value of Maintainance Charges
Year	Net Cash Flows	PV Factor @ 6%	Present Value
1	$5,000	1.0000	$5,000.00
2	$5,000	0.9434	$4,716.98
3	$5,000	0.8900	$4,449.98
4	$5,000	0.8396	$4,198.10
5	$5,000	0.7921	$3,960.47
6	$5,000	0.7473	$3,736.29
7	$5,000	0.7050	$3,524.80
8	$5,000	0.6651	$3,325.29
Net Present Value (B)	$32,911.91