Question

5.5     You may use the Excel spreadsheet named LeasevsBuy.xls to answer the following question. If you choose to answer the question without using the spreadsheet, be careful to show all work, so your marker can follow your calculation and award partial marks as needed.                                               (10 marks)

You want to acquire a new car, but you’re not sure whether you should lease it or buy it. You can buy your chosen model for $50,000. You expect it to be worth $20,000 after you use it for three years. Alternatively, you could lease it for $650 per month for a three-year term, with the first payment due immediately. The lease company has not told you what interest rate they’re using to calculate the monthly payments, but you know you could borrow money at an annual percentage rate (APR) of 8%.Assume your tax rate is 40%. If you were to use this car 100% for business, rendering the lease payments tax-deductible, or alternatively, allowing you to deduct depreciation straight-line at $10,000 per year for three years, would you prefer to buy or lease the car? (Hint: Use the after-tax borrowing rate to discount the cash flows.)

d) Calculate the salvage value at which you should be indifferent between leasing and buying. (2 marks)

e) Assume your tax rate is 40%. If youAssume your tax rate is 40%. If you were to use this car 100% for business, rendering the lease payments tax-deductible, or alternatively, allowing you to deduct depreciation straight-line at $10,000 per year for three years, would you prefer to buy or lease the car? (Hint: Use the after-tax borrowing rate to discount the cash flows.)

Answer 1

Car Price	50000
Salvage Value	20000
Discount Rate	8%
Depreciation	10000
Tax Benefit	4000
Duration	3
Buy Option	Year	0	1	2	3
	Cash Flow	-50000	4000	4000	24000
	NPV=	($16,203.42)
Lease Option	Cash Flow	0	-4680	-4680	-4680
	NPV=	($8,203.74)
Hence Lease option is economical
At 35000 Salvage value , the NPV of Buy Option and lease option will be indifferent..