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 8 years and then sold for $12,000 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 $162,000 in cash. All maintenance and insurance costs, which approximate $7,000 per year, would be paid by Kiddy.

2.Lease machine. The machine could be leased for a 8-year period for an annual lease payment of $27,000 with the first payment due immediately. All maintenance and insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lollie at the end of the 8-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, find the present value for the following options. Ignore income tax considerations. Determine which option Kiddy should choose. (Negative amounts should be indicated by a minus sign. Round your final answers to nearest whole dollar amount.)

Answer 1

Solution:

Computation of Present value of Cash outflows for buy and lease option - Kiddy Toy Corporation
Particulars	Period	Amount	PV Factor	Present Value
Buying Option:
Cost of Machine	0	-$162,000.00	1.00000	-$162,000
Annual maintenance and insurance cost	1-8	-$7,000.00	5.33493	-$37,344
Salvage Value	8	$12,000.00	0.46651	$5,598
Present value of cash outflows - Buying option				-$193,746
Leasing Option:
Annual Lease Rent	0-7	-$27,000.00	5.86842	-$158,447
Present value of cash outflows - Leasing Option				-$158,447

Kiddy toy corporation should choose lease option, it provides highest net present value.