At the end of three years, the fleet could be sold for one-half of the original
ID: 2534845 • Letter: A
Question
At the end of three years, the fleet could be sold for one-half of the original purchase price.
Riteway Ad Agency’s required rate of return is 19%.
Click here to view Exhibit 13B-1 and Exhibit 13B-2, to determine the appropriate discount factor(s) using tables.
Required:
1. What is the net present value of the cash flows associated with the purchase alternative?
2. What is the net present value of the cash flows associated with the lease alternative?
3. Which alternative should the company accept?
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 $15,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole:Explanation / Answer
Solution 1&2:
As present value of cash outflows under leasing option is lower than present value of cash outflows under buying option, therefore company should accept lease alternative.
Computation of Present Value of Purchasing and Leasing option - Riteway Ad Agency Particulars Period Amount PV Factor Present Value Purchasing Option: Purchase price of Car 0 -$150,000.00 1 -$150,000.00 Annual cost of Servicing, taxes and licensing 1-3 -$3,100.00 2.140 -$6,634.00 Repairs - Year 1 1 -$1,000.00 0.840 -$840.00 Repairs - Year 2 2 -$3,500.00 0.706 -$2,471.00 Repairs - Year 3 3 -$5,500.00 0.593 -$3,261.50 Sale Value of Car 3 $75,000.00 0.593 $44,475.00 Present Value of Buying Option (A) -$118,731.50 Leasing Option: Annual lease payment 1-3 -$50,000.00 2.140 -$107,000.00 Security deposit 0 -$10,500.00 1 -$10,500.00 Return of Security deposit 3 $10,500.00 0.593 $6,226.50 Present Value of Leasing Option (B) -$111,273.50Related Questions
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