Your friend Harold is trying to decide whether to buy or lease his next vehicle.

Question

Your friend Harold is trying to decide whether to buy or lease his next vehicle. He has gathered information about each option but is not sure how to compare the alternatives. Purchasing a new vehicle will cost 533,000, and Harold expects to spend about $1,150 per year in maintenance costs. He would keep the vehicle for five years and estimates that the salvage value will be $13,100. Alternatively, Harold could lease the same vehicle for five years at a cost of $4,290 per year, including maintenance. Assume a discount rate of 11 percent. Required: 1. Calculate the net present value of Harold's options. (Future Value of $1, Present Value of S1, Future Value Annuity of S1, Present Value Annuity of S1) (Use appropriate factor(s) from the tables provided. Negative amounts should be indicated by a minus sign. Round your final answers to 2 decimal places. Do not round intermediate calculations.) NPV Purchase Option Lease Option 2. Advise Harold about which option he should choose. O Lease Option O Purchase Option

Explanation / Answer

Req 1: Alternative 1: Purchase the vehicle Net Present value: Present value of cost of vehicle purchase in Year 0 33,000 Add: Present value of Annual maintenance cost 4,250.40 ( $1150 per year for 5 years i.e. Annuity factor of 3.696@11% Less: Present value of Salvage value at the end of 5th year 7,768.30 ($13,100 salvage value at Factor of 0.593 of 5th year) Net Present value of cash outflows 29,482.1 Alternative -2 Lease of Vehicle Present value of Lease rent and Annual maintenance cost 15855.84 ( $ 4,290 per year for 5 years i.e. Annuity factor of 3.696@11% Net Present value of Cash ouflows 15,855.84 NPV Purchase Option -29,482.10 Lease Option -15,855.84 Req 2: Therefore, Harold should lease the vehicle,as present value of cash outflow is lesser in this alternative

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