Final answer:
To determine whether Kiddy should buy or lease the machine, we need to calculate the present value of both options using an interest rate of 10%. If the present value of the buy option is greater, Kiddy should buy the machine. Otherwise, Kiddy should lease the machine.
Step-by-step explanation:
To determine whether Kiddy should buy or lease the machine, we need to calculate the present value of both options.
For the buy option, we will calculate the present value of the $175,000 cash outflow for the purchase, as well as the present value of the $20,000 insurance cost each year for 10 years. We use the interest rate of 10% to discount these cash flows to their present value. At the end of the 10-year period, there will also be a cash inflow of $25,000 from selling the machine, which we also need to discount to its present value. Adding up all the present values gives us the present value of the buy option.
For the lease option, we will calculate the present value of the $40,000 annual lease payment for 10 years. Since the insurance costs are paid for by Lollie Corp., we don't need to discount them. At the end of the 10-year period, the machine will revert back to Lollie, so there is no cash inflow to discount. Adding up all the present values gives us the present value of the lease option.
Finally, we compare the present values of the buy and lease options. If the present value of the buy option is greater than the present value of the lease option, Kiddy should choose to buy the machine. Otherwise, Kiddy should choose to lease the machine.