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 15 years and then sold for $20,000 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 $170,000 in cash. All insurance costs, which approximate $15,000 per year, would be paid by Kiddy.

2. Lease machine. The machine could be leased for a 15-year period for an annual lease payment of $35,000 with the first payment due immediately. All insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lollie at the end of the 15-year period.

Required:
Assuming that a 12% 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
BUY OPTION
LEASE OPTION
KIDDY SHOULD CHOOSE

Answer 1

Given, interest rate = 12%

Option 1: Buy Machine

Given, costs are as follows:

Cost price $170,000 now

Maintenance and insurance costs $15,000 at the end years 1 through 15

Salvage value $20,000 at the end year 15

Present value of costs= 170000 + 15000*(PVA 12%,15) – 20000*(PV 12%,15)

=170000+ 15000* 6.810864 – 20000* 0.182696

= 170000 + 102162.97 – 3653.93 = $268,509

Option 2: Lease Machine

Costs are $35,000 each at the beginning of 15 years

Present value of costs= 35,000*(PVAD 12%, 15)

= 35,000* 7.628168 = $266,986

Present value of costs of lease option is lower than that of buy option. Hence Lease is chosen.