Question

In the late 1990s, car leasing was very popular in the United States. A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car. If the customer decided to keep the car, the customer would pay a price to the manufacturer, the "residual value," computed as 60 percent of the new car price. The manufacturer would then sell the returned cars at auction. In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value). A. Why was the manufacturer losing money on this program

Answer 1

There are two possible explanations for why the manufacturers lost money by leasing cars:

1. the estimated residual value was miscalculated, and probably was actually lower than real market price.
2. the method used to sell returned cars was not efficient. Since returned cars were auctioned, that method was probably not the best way to obtain the highest possible price for the cars. It was a relatively fat method of selling the cars, but not very efficient.

If the residual value was calculated correctly, then the car manufacturers should have changed their method of selling the returned cars, and probably should sell them directly.