Question

In: Finance

Q1. A friend of mine is graduating soon. She accepted a job offer where she will...

Q1. A friend of mine is graduating soon. She accepted a job offer where she will be living away from her family for the next couple of years. She is in the market looking for a new car and she needs your help in order to decide whether to buy or lease. Since she does not know yet if she is going to stay in the new job or not, she wants a short term commitment, two to three years.

She is currently looking at the 2018 Toyota Corolla. Based on the following information and the fact that her opportunity cost is 6%, your recommendation to buy or lease is needed if the decision is over two or three years. A detailed and complete analysis is required to support your claims.

New 2018 Corolla LE Lease –

$179 per Month / 36 Months / $2,878 Due at Signing


OFFER DETAILS


For well-qualified lessees with approved credit through Southeast Toyota Finance. Not all lessees will qualify for this payment amount. Closed-end lease on new 2018 Corolla LE model # 1852 with automatic transmission and select equipment. Adding options increases payment. $179.00 per month for 36 months. $2,878 due at signing includes $2,699 down payment and first month's payment. No security deposit required. $17,582 Adjusted Capitalized Cost is based on down payment; excludes tax, tag, registration, title and dealer fees. Dealer fees vary by dealer. Monthly payments do not include applicable taxes. Lessee pays the remainder of maintenance after ToyotaCare expires, excess wear and use, and $0.18 per mile over 12,000 miles per year. Lease payments total $6,444. Disposition Fee of $350 due at lease-end. May not be combined with certain other offers. Must take delivery between 06/05/18 and 07/09/18.


Assume that the same offer details above apply for 36 month lease and the mileage limit is 36,000 miles, but she won’t go above the mileage limit.


The MSRP for New 2018 Corolla LE is $20,897 (do not worry about taxes). She applied for an auto loan and was able to get 1.99% APR compounded monthly for 24 or 36 months. Auto loan payments are due the end of the month, while lease payments are due the first day of each month. No down payment required to purchase the car.


COST TO OWN A 2018 TOYOTA COROLLA State:


Miles Driven Annually: 12,000 Cost to Own Breakdown Year by Year:


Year 1


Year 2


Year 3


Year 4


Year 5


Total


Depreciation


$4,675


$1,235


$1,164


$1,038


$889


$9,002


Maintenance


$0


$0


$135


$111


$812


$1,057


Repairs


$0


$0


$0


$706


$918


$1,625

Solutions

Expert Solution

It is important to have the conceptual clarity of a Lease or a Buy Offer. Sometimes, just checking for a few parameters can help you quickly solve the question.

In general, a lease is often preferred to a Buy offer. Leasing is often cheaper than buying. The monthly down payments are often lower than the monthly payments for the vehicle costs compunded at the interest rate. For leases, you are basically paying the depreciation and the maintenance cost. You have no obligation of registration, title fees and other vehicle costs as they are already included in the factory cost.

The beginning of month or the end of month really does not make any difference.

In this case, the requirement of the user is short-term, as stated in the caselet. And there is uncertainty about the number of years your friend will be at this job, hence keeping in mind all the conditions, we can easily say it is best to LEASE than to BUY in this case.

Now Analysis:

BUY-

Amount at the end of 24 months= 20897 *[(1+0.0199/100)^36]

=$42477.33

Monthly Payment each year= 42477.33/36 = $1179.92

For each year total payment= $1179.92 +Depreciation+Repair and maintenance

LEASE:

Year I: $2878 which includes first monthly payment

Monthly payment from year 2 TO 5 = $170 for 36 months,

Which is far far lower than the monthly payment if it is bought, even if we do not include depreciation and repairs and maintenance.

Hence the analysis proves our logical reasoning was correct for Lease than Buy.


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