Question

E11-7 Deciding to Lease or Buy [LO 11-3, 11-5] Your friend Harold is trying to decide whether to buy or lease his next vehicle. He has gathered information about each option but is not sure how to compare the alternatives. Purchasing a new vehicle will cost $32,000, and Harold expects to spend about $1,050 p year in maintenance costs. He would keep the vehicle for five years and estimates that th salvage value will be $12,700. Alternatively, Harold could lease the same vehicle for five years at a cost of $4,160 per year, including maintenance. Assume a discount rate of 12 percent Required: 1. Calculate the net present value of Harold's options. (Future Value of $1. Present Value $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Negative amounts should be indicated by a minus sign. Round your final answers to 2 decimal places. Do not round intermediate calculations.) NPV Purchase Option Lease Option 2. Advise Harold about which option he should choose. Lease Option Purchase Option

Answer 1

1)
Net Present Value Purchase Option
Year	Particular	Cashflow	Discounting Factor @12%	Discounted Cash Flow
a	b	c	d	e=d*c
0	Initial Cost	$            -32,000	1.000	$                     -32,000.00
1	Annual Expenses	$               -1,050	0.893	$                           -937.50
2	Annual Expenses	$               -1,050	0.797	$                           -837.05
3	Annual Expenses	$               -1,050	0.712	$                           -747.37
4	Annual Expenses	$               -1,050	0.636	$                           -667.29
5	Annual Expenses	$               -1,050	0.567	$                           -595.80
5	Salvage Value	$              12,700	0.567	$                         7,206.32
	NPV			$                     -28,578.69
Therefore Net Present Value		$      -28,578.69
Net Present Value Lease Option
Year	Particular	Cashflow	Discounting Factor @12%	Discounted Cash Flow
a	b	c	d	e=d*c
1	Lease Payment	$               -4,160	0.893	$                       -3,714.29
2	Lease Payment	$               -4,160	0.797	$                       -3,316.33
3	Lease Payment	$               -4,160	0.712	$                       -2,961.01
4	Lease Payment	$               -4,160	0.636	$                       -2,643.76
5	Lease Payment	$               -4,160	0.567	$                       -2,360.50
	NPV			$                     -14,995.87
Therefore Net Present Value		$      -14,995.87
2)	Harold should choose Lease Option
	(Because negative present value is less than purchase option)