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 10 years and then sold for $10,000 at the end of its useful life. Lollie has presented Kiddy with the following options:1. Buy machine. The machine could be purchased for $160,000 in cash. All insurance costs, which approximate $5,000 per year, would be paid by Kiddy2. Lease machine. The machine could be leased for a 10-year period for an annual lease payment of $25,000 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 10-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.

Answer 1

Answer:

The lease would be a better option as their net preset worth is lower than purcahse the machine and carry their cost.

Explanation:

Option A purchase

F0 -160,000

operating cost 5000 per year we solve for the present value of an annuity

$C \times \frac{1-(1+r)^{-time} }{rate} = PV$

C 5,000.00

time 10

rate 0.12

$5000 \times \frac{1-(1+0.12)^{-10} }{0.12} = PV$

PV -$28,251.1151

PV of the salvage value

$\frac{Maturity}{(1 + rate)^{time} } = PV$  

Maturity  $10,000.0000

time  10.00

rate  0.12000

$\frac{10000}{(1 + 0.12)^{10} } = PV$  

PV   3,219.7324

present worth

-160,000 - 28,251.11 + 3,219.73 = -185.031,38

Option B Lease

10 payment beginning immediatly of $25,000

Therefore, it is an annuity-due

$C \times \frac{1-(1+r)^{-time} }{rate}(1+r) = PV$

C 25,000.00

time 10

rate 0.12

$25000 \times \frac{1-(1+0.12)^{-10} }{0.12}(1+0.12) = PV$

PV -$158,206.2448