PROBLEM 14–25 Net Present Value Analysis of a Lease or Buy Decision LÔ14- The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and then sold the cars after three years of use. The company's present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet, the company is considering two alternatives: Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three years of use. Ten cars will be needed, which can be purchased at a discounted price of $17,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole: Annual cost of servicing, taxes, and licensing Repairs, first year Repairs, second year Repairs, third year $3,000 $1,500 $4,000 $6,000 At the end of three years, the fleet could be sold for one-half of the original purchase price. Lease alternative: The company can lease the cars under a three-year lease contract. The lease cost would be $55,000 per year (the first payment due at the end of Year 1). As part of this lease cost the owner would provide all servicing and repairs, license the cars, and pay all the taxes. Riteway would be required to make a $10,000 security deposit at the beginning of the lease period, whicl would be refunded when the cars were returned to the owner at the end of the lease contract. Riteway Ad Agency's required rate of return is 18%. Required: What is the net present value of the cash flows associated with the purchase alternative Round all dollar amounts to the nearest whole dollar. What is the net present value of the cash flows associated with the lease alternative? Round a 1. 2. dollar amounts to the nearest whole dollar. Which alternative should the company accept? 3.
PROBLEM 14–25 Net Present Value Analysis of a Lease or Buy Decision LÔ14- The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and then sold the cars after three years of use. The company's present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet, the company is considering two alternatives: Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three years of use. Ten cars will be needed, which can be purchased at a discounted price of $17,000 each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole: Annual cost of servicing, taxes, and licensing Repairs, first year Repairs, second year Repairs, third year $3,000 $1,500 $4,000 $6,000 At the end of three years, the fleet could be sold for one-half of the original purchase price. Lease alternative: The company can lease the cars under a three-year lease contract. The lease cost would be $55,000 per year (the first payment due at the end of Year 1). As part of this lease cost the owner would provide all servicing and repairs, license the cars, and pay all the taxes. Riteway would be required to make a $10,000 security deposit at the beginning of the lease period, whicl would be refunded when the cars were returned to the owner at the end of the lease contract. Riteway Ad Agency's required rate of return is 18%. Required: What is the net present value of the cash flows associated with the purchase alternative Round all dollar amounts to the nearest whole dollar. What is the net present value of the cash flows associated with the lease alternative? Round a 1. 2. dollar amounts to the nearest whole dollar. Which alternative should the company accept? 3.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text:PROBLEM 14–25 Net Present Value Analysis of a Lease or Buy Decision LO14-2
The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always
purchased its cars from a dealer and then sold the cars after three years of use. The company's
present fleet of cars is three years old and will be sold very shortly. To provide a replacement fleet,
the company is considering two alternatives:
Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after three
years of use. Ten cars will be needed, which can be purchased at a discounted price of $17,000
each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole:
Annual cost of servicing, taxes, and licensing
Repairs, first year
Repairs, second year
Repairs, third year
$3,000
$1,500
$4,000
$6,000
At the end of three years, the fleet could be sold for one-half of the original purchase price.
Lease alternative: The company can lease the cars under a three-year lease contract. The lease cost
would be $55,000 per year (the first payment due at the end of Year 1). As part of this lease cost,
the owner would provide all servicing and repairs, license the cars, and pay all the taxes. Riteway
would be required to make a $10,000 security deposit at the beginning of the lease period, which
would be refunded when the cars were returned to the owner at the end of the lease contract.
Riteway Ad Agency's required rate of return is 18%.
Required:
1.
What is the net present value of the cash flows associated with the purchase alternative?
Round all dollar amounts to the nearest whole dollar.
What is the net present value of the cash flows associated with the lease alternative? Round all
dollar amounts to the nearest whole dollar.
Which alternative should the company accept?
2.
3.
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