1) Drive a Brand-New Honda Civic Today! You just received a letter from your neighborhood Honda dealership, which says the following:

Drive a brand-new Honda Civic today (MSRP* $23,270.00)!

Two financing options:

1) Loan Option:

- Amount due at signing: $599 (includes taxes, titles, and dealer fees).

- Loan term: 3 years (loan fully repaid by the end of the 3 years).

- Quarterly payments (due at the end of each quarter): $2,047.04.

2) Leasing Option**:

- Amount due at signing: $2,299.00 (includes taxes, titles, and dealer fees).

- Leasing term: 3 years - Monthly payments (due at the beginning of each month): $249.00.

- Option to buy at the end of the 3 years: $14, 660.10.

- Lessee responsible of maintenance, insurance, excessive wear and tear, and 15/mile if vehicle driven over 12,000 miles/year. Payment for any excess mileage is to be paid at the end of each year.

Hurry! Offer ends soon! See your Honda dealer for complete details.

*MSRP: Manufacturer-Suggested Retail Price.

**Leasing: A type of financing contract whereby the lessee (user of the vehicle) does not own the vehicle, which remains the property of the dealership, until the lessee decides whether or not to exercise his/her option to purchase the vehicle at the end of the lease term.

Questions: Assume that you intend to drive the vehicle for approximately 15,000 miles per year.

1) What is the all-in cost of the loan financing option? (Hint: that cost must be expressed as Effective Annual Rate of interest (EAR)).

2) What is the all-in cost of the leasing option (also expressed as an EAR)?

3) Which one will you choose based on your two answers above?

4) In addition to the purely financial aspect, what are the pros and cons of these two financing options? At the end of the day, which of the two would you prefer? Explain why. (Note: this second question is a discussion question, there is no calculation necessary).

(Hint: The best way to resolve this problem is to lay out, for each financing option, all the relevant cash flows on a timeline, making sure that each cash flow is properly placed, and then solve for the interest rate (internal rate of return-IRR) that equates inflows with outflows). As for all similar problems, the timing of these cash flows is key (time value of money!) Once you have the IRRs for each financing option, you then convert them into EAR in order to compare them and make your decision.)