Question

ordano is per purce follo eds a car for the next six years. He is curto 100 or lease it from CheapLease Inc. If Toby deci s. He is currently Toby Gordano is starting school in September, and needs a car for the ne deciding to either purchase a used car for $25,000 or lease it from Che car, he would incur the following costs per year: oby decides to buy Maintenance Insurance Car Wash Gas $2,100 1,800 800 900 t of $8,700 per year On the other hand, Toby can lease the car under a six-year agreement at a lease cost of $8700 As part of the lease, CheapLease Inc. would provide all the required maintenance. Toby w responsible for the cost of car washes, gas and insurance. enance. Toby would still be Assume Toby has a required rate of return of 12%. Required a) Using the NPV method, which alternative should Toby choose?

Answer 1

1) Calculation of best alternative

Option 1

Car Lease option                 $
Lease cost	8700
Insurance	1800
Car wash	800
Gas	900
Total Cost per year	12200
PVF @ 12% for 6 years	4.111407324
NPV of total cost	50159.16935

Option 2

Car Buy Option                  $
Maintenance	2100
Insurance	1800
Car wash	800
Gas	900
Total Cost per year	5600
PVF @ 12% for 6 years	4.111407324
NPV of total cost	23023.88101
Initial Payment	25000
Total NPV	48,024

Looking at both the options, buying the car is more beneficial than leasing for Toby Gordano.

2) Lease payment at which Toby would be indifferent is:

Particulars	$
Maintenace cost annuity (2100*4.11141) - (c)	(8,634)
NPV of total cost calculated above under option 2 - (d)	23,024
Total NPV Cost excluding Maintenance (common cost under lease option) - (b) = (c)-(d)	14,390
Total NPV Cost under Car buy option - (a)	48,024
NPV of lease payment - (a)-(b)	33,634
Annuity Factor @ 12% for 6 years	4
Monthly Lease Payment	8,181

Toby would be indifferent for purchasing or leasing the car at lease payment of $8,181 per month