Question

12-25 net present value analysis of a lease or buy decision

Problem 12-25 Net Present Value Analysis of a Lease or Buy Decision (L012-2] 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 $17,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a wholet Annual cost of servicing, taxes, and licensing Repairs, first year Repairs, second year Repairs, third year $5,000 $ 2,900 $ 5,400 $ 7,400 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 $69,000 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 fake a $14,500 security deposit at the beginning of the lease pertod, 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 19%. Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determine the appropriate discount factor(s) using tables. Required:

Answer 1

1	Computation of net present value of the cash flows associated with the purchase alternative
	Purchase Alternative	Now	1	2	3
	Purchase of Car ($17,000 * 10)	(170,000.00)
	Annual Servicing Cost		(5,000.00)	(5,000.00)	(5,000.00)
	Repair		(2,900.00)	(5,400.00)	(7,400.00)
	Resale Value of Car				85,000.00
	Total Cash Flows	(170,000.00)	(7,900.00)	(10,400.00)	72,600.00
	Discounted Factor @19%	1.00	0.84034	0.70616	0.59342
	Present Value	(170,000.00)	(6,638.66)	(7,344.11)	43,081.99
	Net Present Value	= -170,000 - 6,638.66 - 7,344.11 + 43,081.99
		(140,900.78)

2	Computation of net present value of the cash flows associated with the lease alternative
	Lease Alternative	Now	1	2	3
	Security Deposit	(14,500.00)
	Annual Lease Payment		(69,000.00)	(69,000.00)	(69,000.00)
	Refund of Deposit				14,500.00
	Total Cash Flows	(14,500.00)	(69,000.00)	(69,000.00)	(54,500.00)
	Discounted Factor @19%	1.00	0.84034	0.70616	0.59342
	Present Value	(14,500.00)	(57,983.19)	(48,725.37)	(32,341.16)
	Net Present Value	= - 14,500 - 57,983.19 - 48,725.37 - 32,341.16
		= (153,550)

3. The company should accept "Purchase Alternative" as it has lower net pesent value of cash ouflows