Question

Your friend Harold is trying to decide whether to buy or lease his next vehicle. He has gathered information about each option but is not sure how to compare the alternatives. Purchasing a new vehicle will cost $28,500, and Harold expects to spend about $700 per year in maintenance costs. He would keep the vehicle for five years and estimates that the salvage value will be $11,300. Alternatively, Harold could lease the same vehicle for five years at a cost of $3,705 per year, including maintenance. Assume a discount rate of 10 percent.

Requirement:
1. Calculate the net present value of Harold’s options. (Future Value of $1, Present Value of $1, Future Value Annuity of $1, Present Value Annuity of $1.) (Use appropriate factor(s) from the tables provided. Negative amounts should be indicated by a minus sign. Round your final answers to 2 decimal places.
2. Advise Harold about which option he should choose.
Lease Option
Purchase Option

Answer 1

$-24,137.14

$-14,044.86

He should choose the lease option

Step-by-step explanation:

Net present value is the present value of after-tax cash flows from an investment less the amount invested.

NPV can be calculated using a financial calculator

Purchase option

Cash flow in year 0 = $-28,500

Cash flow in year 1 - 4 = -700

Cash flow in year 2 = 11,300 - 700 = 10,600

I = 10%

NPV= -24,137.14

Lease option

Cash flow in year 1 - 5 = 3705

I = 10%

NPV= -14,044.86

the lease option is less expensive and should be chosen

To find the NPV using a financial calculator:

1. Input the cash flow values by pressing the CF button. After inputting the value, press enter and the arrow facing a downward direction.

2. after inputting all the cash flows, press the NPV button, input the value for I, press enter and the arrow facing a downward direction.

3. Press compute