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old PROBLEM 13-25 Net Present Value Analysis of a Lease or Buy Decision L013-20 The Riteway Ad Agency provides cars for its sales staff In the past, the company has always purchased its curs 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 whole Annual cost of servicing taxes, and licensing $3,000 Ropairs, first yoar $1,500 Repairs, second year $4,000 Repairs, third yoar $6,000 At the end of three years, the fleet could be sold for one-half of the original purchase price. Loase alternative: The company can lease the cars under a three-year lease contract. The case cost would be 555,000 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 make a $10,000 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. - 1 o WA accepted the following costs will be incurred on the fleet as a whole: Annual cost of servicing, taxes, and licensing $3,000 Repairs, first year $1,500 Repairs, second year $4,000 Repairs, third year $6,000 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 $55.000 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 make a $10,000 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 18% Required: 1. What is the net present value of the cash flows associated with the purchase alternative Round all dollar amounts to the nearest whole dollar 2. What is the net present value of the cash flows associated with the lease alternative? Round all dollar amounts to the nearest whole dollar 3. Which alternative should the company accept? Problem 13-25 (30 minutes) 1. The present value of the purchase alternative is computed as follows: Purchase Alternative: Now 1 N 3 Purchase of cars Annual servicing costs. Repairs......... Resale value of cars.... Total cash flows (a)..... Discount factor (b)....... Present value (a) (b) .. Net present value...... 2. The present value of the lease alternative is computed as follows: Lease Alternative: Now 1 2 3 Security deposit........... Annual lease payments Refund of deposit........ Total cash flows (a)..... Discount factor (b)....... Present value (a) (b).. Repairs Resale value of cars.... Total cash flows (a).... Discount factor (b)....... Present value (a) (b).. Net present value....... 2. The present value of the lease alternative is computed as follows: Lease Alternative: Now 1 2 3 Security deposit Annual lease payments Refund of deposit........ Total cash flows (a)..... Discount factor (b)....... Present value (a) (b).. Net present value... 3
