You are considering obtaining a car for personal use you hav

You are considering obtaining a car for personal use, you have two alternatives, one purchase the car using a loan from your bank, or lease the car from the dealer. If you borrow, the bank will require monthly payments and will charge you 6.20% for a 3 year loan. If you lease, the dealer will require payments of $260 at the end of each month for 3 years plus a final payment of $13,700 at the end of the third year if you want to keep the car. For a $20,000 car, what is the cost of leasing and which alternative provides the best financing over the 3 years? Also, please show how to entering number in financial calculator HP 10bII+

Solution

In order to compare which financing is better, we need to calculate the financing rate that is a result of leasing facility provided by company. One that offers a lower interest rate financing should be preferable.

We already know, the cost of borrowing by loan is 6.20% APR which means monthly rate here = 6.20%/12 = 0.52%

We need to calculate the financing rate for leasing and we can do that easily on calculator by following steps, but before that, let us first define the PV, FV, PMT and N inputs for calculator.

N = 3 Years. However, payment is made monthly. So N = 12 * 3 = 36 months

Monthly payment, PMT = - $260. Negative sign indicate that you need to make this payment, i.e., it is a cash outflow.

Present value, PV = $20,000 which is the value of car or the value that we get today. Since, it what we get (or an inflow) it should be in positive.

Future Value, FV = -$13,700 which is again negative as this has to be made to the dealer and represents a cash out flow for us.

Now let us look at the steps:

Look at 2 special keys in your calculator: Gold Key and Purple Key, which are like shift keys for specific functions mentioned on other keys of calculator in same color.

Step 1: While using any financial calculator, first step should always be clearing the memory registers of calculator. To accomplish this all you need to do is simply press the [Gold key] followed by the [C key].

Step 2: Now, we need to enter the inputs that we defined earlier. First enter “36” using numeric keypad and press [N].

Step 3: Now, enter “20000” using numeric keypad and press [PV].

Step 4: Now enter “260” using numeric keypad and press [+/-] key to change this number to negative. Press [PMT].

Step 5: Now enter “13700” using numeric keypad and press [+/-] key to change this number to negative. Press [FV].

Step 6: Pres [I/YR] key, which would display the interest rate on the screen, which in this case would be 0.4991…, which implies 0.4991% or 0.50%.

This is lower than 0.52% financing rate offered by bank.

Hence, leasing structure by dealer is more attractive and cheaper.

Leasing cost/year APR = 0.4991% * 12 = 5.99%