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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

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 companys 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. If the new cars are purchased, then the costs incurred by the company will be as follows:

Purchase cost of a new fleet: 10 cars at $17,000 each $ 170,000
Annual cost of servicing, licences, and taxes for the fleet $ 3,000
Repairs for the fleet:
First year $ 1,500
Second year $ 4,000
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 Agencys required rate of return is 18%.

Required:

1. What is the net present value of the cash flows associated with the purchase alternative?

2. What is the net present value of the cash flows associated with the lease alternative?

3. Which alternative should the company accept?

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