The Riteway Ad Agency provides cars for its sales staff. In the past, the compan

Question

The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and then sold the cars after three years of use. The company's present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet, the company is considering two alternatives: Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three years of use. Ten cars will be needed, which can be purchased at a discounted price of dollar 22,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole: Annual cost of servicing, taxes, and licensing dollar 3,800 Repairs, first year dollar 1,700 Repairs, second year dollar 4,200 Repairs, third year dollar 6,200 At the end of three years, the fleetcould be sold for one-half of the original purchase price. Lease alternative: The company can lease the cars under a three-year lease contract. The lease cost would be dollar 57,000 per year (the first payment due at the end of year 1). As part of this lease cost the owner would provide all servicing and repairs, license the cars, and pay all the taxes. Riteway would be required to make a dollar 14,000 security deposit at the beginning of the lease period, which wouId be refunded when the cars were returned to the owner at the end of the lease contract. Riteway Ad Agency's required rate of return is 16 percent. Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount fector(s) using tables. Required: 1. Use the total-cost approach to determine the present value of the cash flows associated with each alternative. (Any cash outflows should be indicated by a minus sign. Round discount factors(s) to 3 decimal places.)

Explanation / Answer

Present Value of cash flow associated with each alternative are shown below:

Lease alternative is better.

Now 1 2 3 Purchase Alternative:    Purchase of Car -220000    Annual servicing Cost -3,800 -3,800 -3,800    Repair -1700 -4200 -6200    Resale of cars 110000 Total Cash Flow -220000 -5500 -8000 100000 Discount factor 1 0.862 0.743 0.641 Present Value -220000 -4741 -5944 64100 Net present value -166585 Lease Alternative:    Security deposit -14,000    Annual lease payment -57,000 -57,000 -57,000    Refund of deposit 14,000 Total Cash Flow -14,000 -57,000 -57,000 -43,000 Discount factor 1 0.862 0.743 0.641 Present Value -14000 -49134 -42351 -27563 Net present value -133048

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.