Reference no: EM133007507

Honey Inc., has decided to acquire a new piece of equipment. It may do so by an outright cash purchase at P25,000 or by a leasing alternative of P6,000 per year for the life of the machine. Other relevant information follows:

Purchase price due at time of purchase P25,000
Estimated salvage value if purchased 3,000
Estimated useful life (years) 5
Annual cost of maintenance contract to be
Acquired with either lease or purchase 500

The full purchase price of P25,000 could be borrowed from the bank at 10% annual interest and could be repaid in one payment at the end of the fifth year.

Additional information:

a. Assume a 40% income tax rate and use of the straight-line method of depreciation.
b. The yearly lease rental and maintenance contract fees would be paid at the beginning of each year.
c. The minimum desired rate of return on investment is 10%.
d. All cash flows, unless otherwise stated, are assumed to occur at the end of the year.

Selected present value factors for a 10% return are given below:
Present Value
Of P1 Received
Year at end of Year__
0 P1.000
1 .909
2 .826
3 .751
4 .683
5 .621

Problem 1: Under the purchase alternative the present value of the estimated salvage value is:

A. P0
B. P3,000
C. P1,863
D. P2,049