The Wrongway Ad Agency provides cars for its sales staff. In the past, the compa
ID: 2456430 • Letter: T
Question
The Wrongway 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 as follows:
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 $18,300 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole:
Lease Alternative. The company can lease the cars under a three-year lease contract. The lease cost would be $57,750 per year (with 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. Wrongway would be required to make a $21,250 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.
Click here to view Exhibit 10-1 and Exhibit 10-2, to determine the appropriate discount factor(s) using tables.
Use the total cost approach to determine the present value of the cash flows associated with each alternative. (Negative amounts should be indicated with a minus sign. Round discount factor(s) to 3 decimal places. Round other intermediate calculations and final answers to the nearest whole dollar amounts.)
what is the purchase value of cash flows for the purchase of fleet and lease of cars?
The Wrongway 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 as follows:
Explanation / Answer
Purchase Alternative
Cash Flow
Year 0 = Purchase cost
Year 0 = - 18300*10
Year 0 = -183000
Year 1 = - Annual cost of servicing, taxes, and licensing - Repair Cost
Year 1 = -6450-1850
Year 1 = -8300
Year 2 = - Annual cost of servicing, taxes, and licensing - Repair Cost
Year 2= -6450-4150
Year 2 = -10600
Year 3 = - Annual cost of servicing, taxes, and licensing - Repair Cost + Salvage Value
Year 3= -6450-6300 + 50%*183000
Year 3 = 78750
Present value of the cash flows associated = Year 0 Cash Flow + Year 1 Cash Flow*PVIF(rate,nper) + Year 2 Cash Flow*PVIF(rate,nper) + Year 3 Cash Flow*PVIF(rate,nper)
Present value of the cash flows associated = -183000 -8300*PVIF(18%,1) -10600*PVIF(18%,2) +78750*PVIF(18%,3)
Present value of the cash flows associated = -183000 -8300*0.847 -10600*0.718 +78750*0.609
Present value of the cash flows associated = - $ 149,682
Lease Alternative
Cash Flow
Initial Investment = Security Deposit
Initial Investment = -21250
Annual cash outfow = -57750
Terminal Cash Flow = 21250
Present value of the cash flows associated =Initial Investment + Annual Cash Flow*PVIFA(rate,nper) + Terminal Cash Flow*PVIF(rate,nper)
Present value of the cash flows associated = -21250 - 57750*PVIFA(18%,3) + 21250*PVIF(18%,3)
Present value of the cash flows associated = -21250 - 57750*2.174 + 21250*0.609
Present value of the cash flows associated = - $ 133,857
Decision : Select Lease alternative as its Present value of the cash out flows is lower than purchase alternative
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