Question

Ben Halls is trying to decide whether to lease or purchase a new car costing $18,000. If he leases, he’ll have to pay a $600 security deposit and monthly payments of $450 over the 36-month term of the closed-end lease. Ben could earn 1% on the amount of any down payment or security deposit. On the other hand, if he buys the car then he’ll have to make a $2,400 down payment and will finance the balance with a 36-month loan with a 4% interest rate; he’ll also have to pay a 6 percent sales tax ($1,080) on the purchase price, and he expects the car to have a residual value of $6,500 at the end of 3 years. Ben can earn 4 percent interest on his savings.

Find the total cost of both the lease and the purchase and then recommend the best strategy for Ben.

Answer 1

Ans

If Ben leases the car than his total cost can be calculated as under:

• he will have to pay $600 towards security deposit.
• His monthly lease payments for 36 months will be $450.
• His total savings will be $2880 (down payment + sales tax) on which he can earn 4% interest.
• He will also earn 1 % interest on the security deposit of $600.
• He will get back security deposit of $600 at the end of lease period.

On the basis of above points his cash flows can be calculated as under:

Thus, if he leases a car then his total cost will be $15,674.40.

On the other hand, if he buys the car then the following points need to be kept in mind:

• He needs to pay upfront $2400 for down payment and $1080 for sales tax.
• He needs to pay 36 EMI of $ 460.57.
• He will get back residual value of car of $ 6500 at the end of 36 months.

On the basis of above, his cash flows will be as under:

So, if he buys the car then his total cost will be $13,560.67.

However, the NPV if he buys the car is $(10,607.82) as compared to NPV of $ (8686.46) if he leases the car. So, we recommend him to lease the car.