Question

In: Finance

You own a car rental company, and you have two options to replace your fleet. For...

You own a car rental company, and you have two options to replace your fleet. For each car, you can either enter into a five-year lease for $7,000 per year (pretax) or you can purchase the car for $30,000. You believe the cars will last for 8 years and be worth $4,000 at the end of the 8 years. The lease payments cover maintenance costs, but if you buy the cars, you will pay $1,200 per year (pre-tax) for a maintenance contract on each car and depreciate the cars straight line over eight years. You can then sell the cars at the end of the eighth year. Your required return on this investment is 12% and the firm’s tax rate is 21%. Assume all cash flows occur at the end of the year. What is the EAA of the purchase option, and should you lease or purchase the cars?

Solutions

Expert Solution

Equated Annual Annuity of Lease Option is ($5,530) (Note 1)

Equated Annual Annuity of Purchase Option is ($5,942.67) (Note 2)

Therefore, You should Lease the car as EAA of Lease is less than Purchase

jeff jeffy answered 1 year ago
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