Question

Harding Company is in the process of purchasing several large pieces of equipment from Danning Machine Corporation. Several financing alternatives have been offered by Danning (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. Pay $1,000,000 in cash immediately. 2. Pay $420,000 immediately and the remainder in 10 annual installments of $80,000, with the first installment due in one year. 3. Make 10 annual installments of $135,000 with the first payment due immediately. 4. Make one lump-sum payment of $1,500,000 five years from date of purchase. Determine the present value, assuming that Harding can borrow funds at an 8% interest rate.

Answer 1

A student needs to calculate the present value of different payment options for equipment purchase using an 8% interest rate. This requires a discounted cash flow analysis using present value calculations for each payment or series of payments. The sum of these present values shows the total cost effectiveness of each financing alternative.

Step-by-step explanation:

The student is tasked with determining the present value of various payment options offered for purchasing equipment, assuming an 8% interest rate. To calculate the present value for each financing alternative, a discounted cash flow analysis is necessary. This involves using present value tables or formulas to discount each payment back to its present value and adding these values together to find the total present value for each option. Each option presents a different set of cash flows which must be evaluated separately.

For example, the second option with a $420,000 immediate payment and 10 annual installments of $80,000 can be calculated by using the Present Value of an Annuity (PVA) formula for the installments, plus the present value of the immediate payment, which is already in present terms. Similarly, the fourth option's lump-sum payment due in five years can be discounted back to the present using the Present Value (PV) formula. A comparison of the present values of all options will reveal the most cost-effective choice at the given interest rate.