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. Pur Harold expects to spend about $1,050 per year in maintenance costs. He would keep the vehidle for five years and estimates that the salvage value will be $12,700. Alternatively, Harold could lease the same vehicle for five years at a cost of $4,160 per year, including maintenance. Assume a discount rate of 12 percent Required: 1. Calculate the net present value of Harold's options. (Future Value of $1. Present Value of $1, Future Value Annuity of $1. Present Value Annuity of $1.) (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.) Purchase Option Lease Option 2. Advise Harold about which option he should choose. O Lease Option O Purchase Option

Explanation / Answer

Answer 1 Calculation of NPV of Lease option Year Lease payments Discount Factor @ 12% Present values 1 -$4,160.00        0.89286 -$3,714.29 2 -$4,160.00        0.79719 -$3,316.33 3 -$4,160.00        0.71178 -$2,961.01 4 -$4,160.00        0.63552 -$2,643.76 5 -$4,160.00        0.56743 -$2,360.50 NPV -$14,995.87 Calculation of NPV of Purchase option Year 0 1 2 3 4 5 NPV Cost of new vehicle -$32,000 Maintenance cost of vehicle -$1,050 -$1,050 -$1,050 -$1,050 -$1,050 Salvage Value of vehicle $12,700 Net Cash flow -$32,000 -$1,050 -$1,050 -$1,050 -$1,050 $11,650 Discount Factor @ 12%        1.00000        0.89286      0.79719      0.71178      0.63552       0.56743 Present Values -$32,000.00 -$937.50 -$837.05 -$747.37 -$667.29 $6,610.52 -$28,578.69 NPV Lease Option -$14,995.87 Purchase Option -$28,578.69 Answer 2 Harold should choose Lease option as it has less net present value of cash outflow compared to purchase option.

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