The Riteway Ad Agency provides cars for its sales staff. In the past, the company has always purchasedits cars from a dealer and then sold the cars after three years of use. The company’s present fleet of cars isthree years old and will be sold very shortly. To provide a replacement fleet, the company is consideringtwo alternatives:Purchase alternative: The company can purchase the cars, as in the past, and sell the cars after threeyears of use. Ten cars will be needed, which can be purchased at a discounted price of $17,000each. If this alternative is accepted, the following costs will be incurred on the fleet as a whole:Annual cost of servicing, taxes,and licensing ........................................... $3,000Repairs, first year ....................................... $1,500Repairs, second year .................................. $4,000Repairs, third year ...................................... $6,000At 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 costwould 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. Ritewaywould be required to make a $10,000 security deposit at the beginning of the lease period, whichwould 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:(Ignore income taxes.)1. Use the total-cost approach to determine the present value of the cash flows associated with eachalternative. Round all dollar amounts to the nearest whole dollar.2. Which alternative should the company accept?
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 ........................................... $3,000
Repairs, first year ....................................... $1,500
Repairs, second year .................................. $4,000
Repairs, third year ...................................... $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
Required:
(Ignore income taxes.)
1. Use the total-cost approach to determine the present value of the
alternative. Round all dollar amounts to the nearest whole dollar.
2. Which alternative should the company accept?
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