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 $31,500, and Harold expects to spend about $1,000 per year in maintenance costs. He would keep the vehicle for five years and estimates that the salvage value will be $12,500. Alternatively, Harold could lease the same vehicle for five years at a cost of $4,095 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 $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.)

             

2. Advise Harold about which option he should choose.

    

	Lease Option
	Purchase Option

Answer 1

Calculation of net present value of Purchase option
Year	0	1	2	3	4	5
Purchase alternative
Purchase of vehicle	-$31,500
Maintenance cost		-$1,000	-$1,000	-$1,000	-$1,000	-$1,000
Salvage value of vehicle						$12,500
Net Cash flows	-$31,500	-$1,000	-$1,000	-$1,000	-$1,000	$11,500
x Discount Factor @ 11%	1.000	0.901	0.812	0.731	0.659	0.593
Present Values	-$31,500	-$901	-$812	-$731	-$659	$6,825
Net Present Value	-$27,777.76
Calculation of net present value of Leasing option
Year	0	1	2	3	4	5
Lease alternative
Annual lease payments		-$4,095	-$4,095	-$4,095	-$4,095	-$4,095
Net Cash flows		-$4,095	-$4,095	-$4,095	-$4,095	-$4,095
x Discount Factor @ 11%	1.000	0.901	0.812	0.731	0.659	0.593
Present Values	$0	-$3,689	-$3,324	-$2,994	-$2,698	-$2,430
Net Present Value	-$15,134.70
	Net Present Value
Lease Option	-$15,134.70
Purchase Option	-$27,777.76
Harold should choose lease option as there is net advantage of leasing of $12,643.06 [-$15,134.70 - (-$27,777.76)]