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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281

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Intermediate Accounting: Reporting...

3rd Edition
James M. Wahlen + 2 others
ISBN: 9781337788281
Textbook Problem
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Acquisition of Equipment

Taylor Company’s manager has consulted you, the controller, as to which of the following plans you would recommend in acquiring the use of a piece of heavy equipment:

  1. 1. Purchase the equipment and pay immediately a cash price of $36,800. The service life of the heavy equipment is estimated to be 5 years, with a resale value at the end of that time of $5,500.
  2. 2. Lease the equipment at the rate of $9,100 per year for 5 years, payable at the beginning of each year.

Required:

Assuming that the time value of money is 12%, evaluate the two alternatives and indicate which plan you would recommend to the manager, stating the value of savings to the company.

To determine

Identify the best plan, and also show the value of savings for the company.

Explanation

 Annuity: An annuity is referred as a sequence of payment of fixed amount of cash flows that occurs over the equal intervals of time.

Plan 1:

Calculate the present value of the resale value of the equipment, using present value of annuity due.

Present value of the resale value=Cash flow×(pn,i)=$5,500×(pn=5,i=12%)=$5,500×0.567427=$3,120.85

0.567427 is a factor of present value of $1 for 5 periods at 12% interest rate. This value is taken from present value of $1 table.

Calculate the total present value of the purchase of equipment.

Initial cash payment$36,800.00
Present value of the resale value($3,120.85)
Total present value$33,679.15

Thus, present value of plan 1 is $33,679.15.

Plan 2:

Determine the present value of leasing equipment, using the present value of annuity due formula

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