H needs to acquire a highly specialized piece of machinery costing $1,200,000 and which has an estimated useful life of ten years. They have asked a finance entity to provide them with an estimate for the cost of acquiring this item. The finance entity has offered the following alternatives:

Package 1. A term loan of $1,200,000, commencing on 1 April 20X0. This will be repaid by means of a series of 10 annual repayments of $195,300. The first repayment will be due one year after the loan is granted. This is equivalent to an interest rate of 10 per cent per annum.

Requirements

(a) Show how the acquisition of the machine under each of the two packages would affect

H’s income statement for the year ended 31 March 20X1 and balance sheet and their related notes as at that data. Assume that the first instalment was paid on 31 March 20X1.

(b) Use your figures to explain why the directors preferred Package 2.