The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and the 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 replacement fleet, the company is considering two alternatives: Purchase alternative: rchase 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 $16,000 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 $ 3,200 $ 1,100 $3,600 Repairs, second year Repairs, third year $ 5,600 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 $51,000 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 $11,000 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.
The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchased its cars from a dealer and the 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 replacement fleet, the company is considering two alternatives: Purchase alternative: rchase 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 $16,000 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 $ 3,200 $ 1,100 $3,600 Repairs, second year Repairs, third year $ 5,600 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 $51,000 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 $11,000 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.
Chapter1: Financial Statements And Business Decisions
Section: Chapter Questions
Problem 1Q
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Transcribed Image Text: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 $16,000 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
$ 3,200
$ 1,100
$3,600
Repairs, second year
Repairs, third year
$ 5,600
At the end of three years, the fleet could be sold for one-half of the original purchase price.
The company can lease the cars under a three-year lease contract. The
lease cost would be $51,000 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 $11,000 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.
Lease alternative:
Riteway Ad Agency's required rate of return is 14%.
Click here to view Exhibit 148-1 and Exhibit 14B-2. to determine the appropriate discount factor(s) using tables.
Required:
1. What is the net present value of the cash flows associated with the purchase alternative?
2. What is the net present value of the cash flows associated with the lease alternative?
3. Which alternative should the company accept?
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