Pad 12:54 PMM *69% )+ The Riteway Ad Agency provides cars for its sales staff. I
ID: 2555352 • Letter: P
Question
Pad 12:54 PMM *69% )+ 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 $14,000 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 Repairs, first year Repairs, second year Repairs, third year 5,400 $ 3,300 S 5,800 $ 7,800 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 $73,000 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 $16,500 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 17%. Click here to view Exhibit 8B-1 and Exhibit 8B-2, to determine the appropriate discount factor(s) using tables. Required 1. Use the total-cost approach to determine the present value of the cash flows associated with each alternative. (Any cash outflows should be indicated by a minus sign. Round discount factor(s) to 3 decimal places.) Now Purchase Alternative: S (140,00o) Purchase of cars Annual servicing costs Repairs Resale value of cars (5,400) (5,800) (5,400) (7,800) (5,400) (3,300)Explanation / Answer
Solution 1:
Solution 2:
As present value of cash outflows for buying option is lesser than present value of cash outflows of leasing option, therefore company should accept purchase alternative.
Computation of Present Value of Purchasing and Leasing option - Riteway Ad Agency Particulars Period Amount PV Factor Present Value Purchasing Option: Purchase price of Car 0 -$140,000.00 1 -$140,000.00 Annual cost of Servicing, taxes and licensing 1-3 -$5,400.00 2.210 -$11,934.00 Repairs - Year 1 1 -$3,300.00 0.855 -$2,821.50 Repairs - Year 2 2 -$5,800.00 0.731 -$4,239.80 Repairs - Year 3 3 -$7,800.00 0.624 -$4,867.20 Sale Value of Car 3 $70,000.00 0.624 $43,680.00 Present Value of Buying Option (A) -$120,182.50 Leasing Option: Annual lease payment 1-3 -$73,000.00 2.210 -$161,330.00 Security deposit 0 -$16,500.00 1 -$16,500.00 Return of Security deposit 3 $16,500.00 0.624 $10,296.00 Present Value of Leasing Option (B) -$167,534.00Related Questions
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