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.)

Answer 1

To determine which option Kiddy should choose, we calculate the present value of both options. Option 1 (Buy Machine) has a total present value of $275,435, while Option 2 (Lease Machine) has a total present value of $245,910. Therefore, Kiddy should choose Option 1: Buy Machine.

Step-by-step explanation:

To determine which option Kiddy should choose, let's calculate the present value of both options and compare them.

Option 1: Buy Machine

The cash outflow for buying the machine is $170,000. The insurance costs are $15,000 per year for 15 years. Using the Present Value of $1 table and a 12% interest rate, we can calculate the present value of the insurance costs as follows:

PV = $15,000 x PVA(12%, 15)

PV = $15,000 x 7.029

PV = $105,435

Adding the present value of the insurance costs to the initial cash outflow, the total present value for this option is $170,000 + $105,435 = $275,435.

Option 2: Lease Machine

The lease payment is $35,000 per year for 15 years. Using the Present Value of $1 table and a 12% interest rate, we can calculate the present value of the lease payments as follows:

PV = $35,000 x PVA(12%, 15)

PV = $35,000 x 7.029

PV = $245,910

The total present value for this option is $245,910.

Comparing the total present values of both options, Kiddy should choose Option 1: Buy Machine as it has a lower total present value ($275,435) compared to Option 2 ($245,910).

Answer 2

Kiddy Toy Corporation

The company should lease. It will save $30,123 by leasing than by buying the machine.

Step-by-step explanation:

a) Data and Calculations:

1. Buy Machine:

Initial cost = $170,000

Annual Insurance Premium = $15,000

Interest rate = 12%

Estimated useful (Lease Period) = 15 years

Insurance Premium for 15 years (PV) = $102,162.97

PV of Salvage value ($20,000 * 0.183) = $3,660

Total cost of buying machine = $268,503 ($170,000 + $102,162.97 - $3,660)

Present value of lease payments = $238,380

NPV of leasing over buying = $30,123 ($268,503 - $238,380)

N (# of periods) 15

I/Y (Interest per year) 12

PMT (Periodic Payment) 35000

FV (Future Value) 0

Results

PV = $238,380.26

Sum of all periodic payments = $525,000.00

Total Interest = $286,619.74

Insurance Premium:

N (# of periods) 15

I/Y (Interest per year) 12

PMT (Periodic Payment) 15000

FV (Future Value) 0

Results

PV = $102,162.97

Sum of all periodic payments $225,000.00

Total Interest $-122,837.03