Question

1. You plan to get a new Honda Civic Coupe when you graduate and are evaluating four alternatives: buy new; buy used, 3-yr lease new; and 3-yr lease new with optional purchase at end of year 3. Use the following data for your analysis of alternatives.
   • Study period is 6 years. (Assume you can make a second 3-yr lease at same terms)
   • Car loan interest rate is 3% APR. (MARR)
   • Planned annual usage is 10,000 miles/yr.  
   • New LX-P model purchase price is $20,500. Salvage (trade-in) value at end of year-6 is $8,200. (Note, also applies to lease with optional purchase alternative).
   • Pre-owned EX-T model (better features than the LX-P) purchase price is $17,500; but it is two years old with 20,000 miles. Salvage value at end of year-6 is $6,000.
   • End-to-End warrantee period is 10 years/100,000 miles.                            
   • 3-year lease new LX-P contract terms: $2,500 initial payment (end of years 0 & 3); $2,300/yr payments (end of years 1 to 6); additional $0.15/mile for usage over 10,000 miles/yr (payable end of years 1 to 6). No salvage value (leasing company owns car).
   • Option to purchase leased LX-P at end of year 3 for $12,500. Salvage value at end of             year-6 is $8,200 (same as new LX-P model buy).    
   • Assume the title, registration, & tax costs; insurance cost; and maintenance costs are identical for all four alternatives

                 A) Draw cash flow diagrams for all four alternatives.

                 B) Determine best alternative using the Annual Equivalent Value on Total Investment                                    evaluation method. (Show your decision analysis work).

                 C) If the loan interest rate increases to 5%, what would be the best alternative?

     D) Is your decision sensitive to driving over 10,000 miles/yr with the added $0.15/mile wear    & tear cost for the 3-yr lease. Note, this cost is refunded if you purchase the car at the             end of the lease period). Provide the rationale for your answer.

Answer 1

		ALTERNATIVE   A
		BUY NEW
	Rate	Car Loan interest	3%
	Pv	Amount of Loan	$20,500
	Nper	Number of years of payment	6
	PMT	Annual Loan   repayment	$3,784	(Using PMT funtion of excelwithRate=3%, Nper=6, Pv=-20500)
		CASH FLOW
		N	A	B=A/(1.03^N)
		Year	Cash flow(Buy New)	Present Value
		1	($3,784)	-$3,674.03
		2	($3,784)	-$3,567.02
		3	($3,784)	-$3,463.12
		4	($3,784)	-$3,362.26
		5	($3,784)	-$3,264.33
	(-3784+8200)	6	$4,416	$3,698.12
			SUM	-$13,633
		Present Worth of costs	-$13,633
		Annual Equivalent Value of costs	($2,517)	(Using PMT funtion of excelwithRate=3%, Nper=6, Pv=-13633)
		PW of costs at 5% discount	-$14,381	(-20500+(8200/(1.05^6))
		ALTERNATIVE   B
		BUY USED
	Rate	Car Loan interest	3%
	Pv	Amount of Loan	$17,500
	Nper	Number of years of payment	6
	PMT	Annual Loan   repayment	$3,230	(Using PMT funtion of excelwithRate=3%, Nper=6, Pv=-17300)
		CASH FLOW
		N	A	B=A/(1.03^N)
		Year	Cash flow(Buy Used)	Present Value
		1	($3,230)	-$3,136.37
		2	($3,230)	-$3,045.01
		3	($3,230)	-$2,956.33
		4	($3,230)	-$2,870.22
		5	($3,230)	-$2,786.62
	(-3230+6000)	6	$2,770	$2,319.45
			SUM	-$12,475
		Present Worth of costs	-$12,475
		Annual Equivalent Value of costs	($2,303)	(Using PMT funtion of excelwithRate=3%, Nper=6, Pv=-12475)
		PW of costs at 5% discount	-$13,023	(-17500+(6000/(1.05^6))
		ALTERNATIVE   C
		3 year LEASED NEW
		CASH FLOW
		N	A	B	C=A+B	PV=C/(1.03^N)	PV1=C/(1.05^N)
		Year	Cash flowLease1	Cah Flow (lease2)	Net Cash Flow (3 yearlease)	Present Value of Cash flow	Present Value at 5% discount
		0	($2,500)		($2,500)	($2,500)	-$2,500
		1	($2,300)		($2,300)	-$2,233	-$2,190
		2	($2,300)		($2,300)	-$2,168	-$2,086
		3	($2,300)	-$2,500	($4,800)	-$4,393	-$4,146
		4		-$2,300	($2,300)	-$2,044	-$1,892
		5		-$2,300	($2,300)	-$1,984	-$1,802
		6		-$2,300	($2,300)	-$1,926	-$1,716
					SUM	($17,247)	($16,334)
		Present Worth of costs	-$17,247
		Annual Equivalent Value of costs	($3,184)	(Using PMT funtion of excelwithRate=3%, Nper=6, Pv=-17247)
		Present Worth of costs at 5%	($16,334)