Question

You are deciding whether to lease or purchase a car. If you lease the car, your annual payments will be $7,400 for the next four years (due at year end). If you buy the car, you will pay $30,000 to purchase the car. You estimate the car will have a resale value of $12,000 at the end of four years. Assume the appropriate discount rate is 10%.

1. Should you lease or buy the car?

2. To answer this question, assume the NPV of the lease cost is $24,000. At what resale value in four years would you be indifferent between buying and leasing?

3. Instead of buying the car for your personal use, you are buying the car for your business. The annual lease payments of $7,400 can be deducted from taxable income. If you purchase the car, you can depreciate the car straight-line to zero book value over four years. The purchase price of the car is $30,000 and the resale value is $12,000. Your marginal corporate tax rate is 40%. If you are acquiring the car for business, should you buy or lease the car?

Answer 1

(A) IF LEASED= LEASE PAYMENT*PVAF(10%,04 YEARS)

=7400*3.170=23458

IF PURCHASED=PURCHASE COST(PVAF10%,0 YEARS)-SALVAGE VALUE*(PVIFA 10%,4 YEAR)

= 30000*1-12000*.683

= 21804

SO THERE IS ADVANTAGE OF PURCHASING IT AS THERE WILL BE REDUCTION OF COST BY 23458-21804=1654

(B) NPV OF LEASING=NET PRESENT VALUE OF BUYING

24000=3000+SALVAGE VALUE*(PVIFA10%4YEARS)

-6000=.683*SALVAGE VALUE

SALVAGE VALUE=6000

(C) IF LEASED =LEASE PAYMENTS NET OF TAXES

7400-0.40*7400=4440*3.170

=14074.8

IF PURCHASED=PURCHASE PRICE - TAX SAVED ON DEPRECIATION(PVAF10%,04 YEARS) - SALVAGE VALUE NET OF TAXES(PVIFA10%04 YEARS)

=3000-3000*3.170-12000*0.60*.683

=15572.4