Question

Problem 12-25 Net Present Value Analysis of a Lease or Buy Decision (LO12-2) 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 -old 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 eplacement 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 $27,eee 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 $ 4,300 $ 2,200 $ 4.700 $ 6,700 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 cost would be $62,eee 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 $11,000 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. Riteway Ad Agency's required rate of return is 15% Click here to view Exhibit 12B-1 and Exhibit 12B-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? Answer is complete but not entirely correct. Complete this question by entering your answers in the tabs below. Reqpired 1 Required 2 Required 3 What is the net present value of the cash flows associated with the purchase alternative? (Round your final answer to a whole dollar amount. Enter negative amount with a minus sign.) Nel present value $ 270,000 Required 1 Required 2 >

Answer 1

Ans:

1.Purchase Alternative
Purchase of Cars	-270,000
Annual Servicing Cost		-4300	-4300	-4300
Repair		-2200	-4700	-6700
Resale Value of Cars				95,000
Total Cash Outflows	-270,000	-6500	-9000	84,000
Discount Factor @15%	1	0.87	0.756	0.658
Present Value	-270,000	-5655	-6804	55,272
Net Present Value of Outflows	-227,187
2.Lease Alternative
Security Deposits	-11,000
Annual Lease Payments		-62,000	-62,000	-62,000
Refund of Security Deposits				11000
Total Cash Outflows	-11,000	-62,000	-62,000	-51,000
Discount Factor@15%	1	0.87	0.756	0.658
Present Value	-11,000	-53940	-46872	-33,558
Net Present Value	-145,370
3.It is better to lease the cars rather than Purchasing as the present value
of cash outflows is more in Purchase alternative compared to lease alternative