6. value 170 points Problem 11-21A Net Present Value Analysis of a Lease or Buy
ID: 2587448 • Letter: 6
Question
6. value 170 points Problem 11-21A Net Present Value Analysis of a Lease or Buy Decision [L011-2] 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 $31,000 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 Repairs, first year Repairs, second year Repairs, third year S 4.700 $ 2,600 $ 5,100 $ 7,100 At the end of three years, the fleet could 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 would be $66,000 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 $13,000 security deposit at the beginning of the lease period, which would be refunded when the cars were returned to the owner at the end of the lease contract cost Riteway Ad Agency's required rate of return is 16%. Click here to view Exhibit 118-1 and Exhibit 113.2, to determine the appropriate discount factor(s) using tables ReauiredExplanation / Answer
OPTION A - IF PURCHASE IS MADE
PRESENT VALUE FOR TOTAL COST OF PURCHASE
YEAR
VALUE
DISCOUNT VALUE @ 16%
PRESENT VALUE
Initial cost ($31000 * 10 cars)
0
-310000
1.0000
-310000
Annual cost
01-03
-4700
2.246
-10556.2
Repairs First Year
1
-2600
0.862
-2241.2
Repairs Second Year
2
-5100
0.743
-3789.3
Repairs Third Year
3
-7100
0.641
-4551.1
Resale value of cars
3
155000
0.641
99355
-231782.8
OPTION B - IF LEASE OPTION IS MADE
PRESENT VALUE FOR TOTAL COST OF LEASE
YEAR
VALUE
DISCOUNT VALUE @ 16%
PRESENT VALUE
Initial Deposit
0
-13000
1.0000
-13000
Annual Lease cost
01-03
-66000
2.246
-148236
Return of Initial Deposit
3
13000
0.641
8333
-152903
From the above both calculations, it is clear that company will incur less cost
if it goes for lease option.
OPTION A - IF PURCHASE IS MADE
PRESENT VALUE FOR TOTAL COST OF PURCHASE
YEAR
VALUE
DISCOUNT VALUE @ 16%
PRESENT VALUE
Initial cost ($31000 * 10 cars)
0
-310000
1.0000
-310000
Annual cost
01-03
-4700
2.246
-10556.2
Repairs First Year
1
-2600
0.862
-2241.2
Repairs Second Year
2
-5100
0.743
-3789.3
Repairs Third Year
3
-7100
0.641
-4551.1
Resale value of cars
3
155000
0.641
99355
-231782.8
OPTION B - IF LEASE OPTION IS MADE
PRESENT VALUE FOR TOTAL COST OF LEASE
YEAR
VALUE
DISCOUNT VALUE @ 16%
PRESENT VALUE
Initial Deposit
0
-13000
1.0000
-13000
Annual Lease cost
01-03
-66000
2.246
-148236
Return of Initial Deposit
3
13000
0.641
8333
-152903
From the above both calculations, it is clear that company will incur less cost
if it goes for lease option.
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