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 12 years and then sold for $11,000 at the end of its useful life. Lollie has presented Kiddy with the following options:1. Buy machine. The machine could be purchased for $161,000 in cash. All maintenance and insurance costs, which approximate $6,000 per year, would be paid by Kiddy.2. Lease machine. The machine could be leased for a 12-year period for an annual lease payment of $26,000 with the first payment due immediately. All maintenance and insurance costs will be paid for by the Lollie Corp. and the machine will revert back to Lollie at the end of the 12-year period.Required:Assuming that an 11% 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, find the present value for the following options. Ignore income tax considerations. Determine which option Kiddy should choose.

Answer 1

To determine which option Kiddy should choose, we need to calculate the present value for each option. For option 1, we calculate the present value of the machine cost, maintenance and insurance costs, and the salvage value. For option 2, we calculate the present value of the lease payments. After calculating the present values, we find that Kiddy should choose option 2: Lease machine.

Step-by-step explanation:

To determine which option Kiddy should choose, we need to calculate the present value for each option. For the first option, we will calculate the present value of the machine cost, maintenance and insurance costs, and the salvage value at the end of 12 years. For the second option, we will calculate the present value of the lease payments. We will use the formula for present value of a single sum and present value of an annuity to calculate the present values.

Option 1: Buy machine

1. Calculate the present value of the machine cost: $161,000 /
   `(1+0.11)^1` = $145,045.81
2. Calculate the present value of the maintenance and insurance costs: $6,000 * (
   `(1-1/(1+0.11)^(12)`) / 0.11) = $43,015.66
3. Calculate the present value of the salvage value: $11,000 /
   `(1+0.11)^(12)` = $2,859.10
4. Add the three present values together: $145,045.81 + $43,015.66 + $2,859.10 = $190,920.57

Option 2: Lease machine

1. Calculate the present value of the lease payments: $26,000 * ((1-1/(1+0.11)^12) / 0.11) = $178,525.36

Comparing the present values, we can see that the present value of option 1 is $190,920.57, while the present value of option 2 is $178,525.36. Therefore, Kiddy should choose option 2: Lease machine.

Answer 2

The machine should be leased because it is cheaper when compared to buying the machine.

Step-by-step explanation:

To determine which option kiddy should choose , we are to calculate the net present value of buying the machine and the present value of payments thay kiddy would make if they lease the equipment.

Net present value is the present value of after tax cash flows from an investment less the amount invested.

NPV can be calculated using a financial calculator:

Cash flow in year 0 = $-161,000

Cash flow each year from year 1 to 11 = $-6,000

Cash flow in year 12 = $-6,000 + $11,000 = $5,000

I = 11%

NPV = $-196,809.89

Present value of lease payment

Cash flow each year from year 1 to 11 = $-26,000

I = 11%

PV = $-161,369.40

The machine should be leased because it is cheaper when compared to buying the machine.

To find the NPV using a financial calacutor:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. After inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute

Present value can be calculated using the same steps as above

I hope my answer helps you