AutoQuest has been selling auto parts to the general public for over 70 years. I
ID: 2483819 • Letter: A
Question
AutoQuest has been selling auto parts to the general public for over 70 years. It has built a reputation for outstanding customer service, becoming the third largest auto parts retailer in the Southwest. Hoping to expand its sales to other regions, managers have decided to establish an online retail presence. Dan Jennings, CIO of AutoQuest, is charged with the task of evaluating how the company should implement this strategy.
One of the first things Dan needs to determine is how to acquire the network servers the company will need. He knows the vendor he wants to use, but is uncertain whether he should buy or lease the servers. If he buys the servers for $4,140,900, AutoQuest will incur annual maintenance costs of $48,150 over their five-year life. If he leases the servers for five years, AutoQuest will make lease payments of $1,155,600 in each of the first three years and of $963,000 in each of the last two years. Annual maintenance costs under the lease will be $77,040.
(a)Calculate the present value of the purchase AND lease option assuming a 12% discount rate
(b)What salvage value would AutoQuest need to receive on the purchased servers at the end of year 5 so that the purchase option is essentially equal to the lease option? Assume a 12% discount rate. (For calculation purposes, use 4 decimal places as displayed in the factor table provided and round final answer to 2 decimal places, e.g. 589.71.)
(c) What annual cash inflow from the new online sales would be necessary for the lease option to be financially acceptable? Assume a 12% discount rate
Explanation / Answer
Answer 1.
If we purchase wee incurred $4,140,900 at year 0 and an annual maintenance cost of $48,150 for five year.
Present Value of Outflow when Purchase @ 12% = 4,140,900 + 48,150/1.12 + 48,150/1.12^2 + ... + 48,150/1.12^5
= 4,140,900 + 48,150*0.56743 = $4,168,221.76
If we lease, then we have to pay 1,155,600 for first 3 years and 963,000 for the last two year with annual maintenance of 77,040.
Present Value of Outflow when Lease @ 12% = 1,155,600 + (1,155,600+77040)/1.12 + (1,155,600+77040)/1.12^2 + (963,000+77040)/1.12^3 + (963,000+77040)/1.12^4 + 77040/1.12^5
= $3,643,743.21
Answer 2
Present Value of Salvage Value of Purchase = 4,168,221.76 - 3,643,743.21
= 524,478.55
Value of Salvage Value after 5 years = 524,478.55*(1.12)^5
= $924,310.41
Answer 3.
Let annual cashflow in lease option be $x so that the present value of inflow must be equal to present value of outflow.
Present Value of Inflow = x/1.12 + x/1.12^2 + ... + x/1.12^5
= x*0.56743
So, 3,643,743.21 = x*0.56743
x = $6,421,484.96
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