Posted: May 4th, 2016

1) If company B has $100,000 cash today, and invested it at a rate of 10% per year for two years, how much will they have in two years?

2) If Company A offers to pay Company B 1,000 in two years, what is the PV of that $121,000 to Company B?

3) What are the implications of these two calculations?

Scenario:

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 10 years and then sold for $10,000 at the end of its useful life. Lollie has presented Kiddy with the following options:

1. Buy machine. The machine could be purchased for $187,000 in cash. All maintenance and insurance costs, which approximate $5,000 per year, would be paid by Kiddy.

2. Lease machine. The machine could be leased for a 10-year period for an annual lease payment of $24,000 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 10-year period.

Question:

(a) 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, find the present value for the following options. Ignore income tax considerations.

1. Buy option

2. Lease option

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