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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 $1,210,000 in cash immediately.
2. Pay $471,000 immediately and the remainder in 10 annual installments of $95,000, with the first installment due in one year.
3. Make 10 annual installments of $157,000 with the first payment due immediately.
4. Make one lump-sum payment of $1,740,000 five years from date of purchase.
Required:
Determine the best alternative for Harding, assuming that Harding can borrow funds at a 7% interest rate. (Round your final answers to nearest whole dollar amount.)

2 Answers

3 votes

Final answer:

To determine the best financing alternative, calculate the present value (PV) of each option and compare. Option 3, making 10 annual payments of $157,000 with the first payment due immediately, has the lowest PV and is the best alternative.

Step-by-step explanation:

To determine the best financing alternative for Harding Company, we need to calculate the present value (PV) of each option. By discounting the cash flows at a 7% interest rate, we can compare the options.

Option 1:

The PV of paying $1,210,000 in cash immediately is $1,210,000.

Option 2:

The PV of paying $471,000 immediately and $95,000 annually for 10 years is $1,086,479.

Option 3:

The PV of making 10 annual payments of $157,000 is $1,005,374.

Option 4:

The PV of making a lump-sum payment of $1,740,000 in 5 years is $1,214,712.

Based on the calculations, Option 3 (making 10 annual payments of $157,000 with the first payment due immediately) has the lowest present value, making it the best alternative for Harding Company.

User Ashish Jambhulkar
by
5.7k points
3 votes

Answer:

The best alternative is alternative 2.

PV = $1138240.246 rounded off to $1138240

Step-by-step explanation:

To determine the best alternative, we need to find the present value of each alternative and the alternative with the lowest present value will be the best one.

To calculate the present value of a single sum, we will use the normal present value formula,

PV = Future Value / (1+r)^t

Where,

  • r is the discount rate
  • t is the time in periods

To calculate the present value of alternative with equal payments over a period of time with same intervals, we will use the present value of annuity formula which is attached.

The present value of alternative 1 is already known.

The present value of alternative 2 will be calculated using the present value of annuity ordinary formula as the payments of 95000 are made at the end of each period.

PV = 471000 + 95000 * [( 1 - (1+0.07)^-10) / 0.07]

PV = $1138240.246 rounded off to $1138240

The present value of alternative 3 will be calculated using the present value of annuity due formula as the payments of 157000 are made at the start of each period.

PV = 157000 * [( 1 - (1+0.07)^-10) / 0.07] * (1+0.07)

PV = $1179891.463 rounded off to $1179891

The present value of alternative 4 will be calculated using the present value

of the sum formula,

PV = 1740000 / (1+0.07)^5

PV = $1240595.952 rounded off to $1240596

The best alternative is alternative 2.

Harding Company is in the process of purchasing several large pieces of equipment-example-1
User High Incompetance
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