Your friend Harold is trying to decide whether to buy or lea

Your friend Harold is trying to decide whether to buy or lease his next a new vehicle will cost $31,500, and Harold ex will be $12,500. Alternatively, Harold could lease the same vehicle for five years at a cost of $4,095 per year, including maintenance. Assume a discount rate of 11 percent his next vehicle. He has gathered information about each option but is not sure how to compare the alternatives Purchasing pects to spend about S 1,000 per year n mantenance costs. He would keep te eie tor ive years snd nina es ha Required: 1. Calculate the net present value of Harold\'s options. (Future Value of $1. Present Value of $1. Future Valve Annuity of $ 1, Present Veue Annuity.of $1.) (Use appropriate factorís) Purchase Option Lease Option

Solution

Evaluation of purchase option

Cost of new vehicle = $ 31,500

Annual maintenance cost = $ 1,000

Useful life of vehicle = 5 years

Scrap value of vehicle after 5 years = $12,500

Present value of cash outflows = 31,500 + 1,000 (PVAF _{11 % , 5} ) - 12,500 (PVF _{11 %, 5} )

= 31,500 + 1,000 x 3.696 - 12,500 x 0.593

= 31,500 + 3696 - 7,412.5

= $ 27,784

Evaluation of lease option

Annual lease = $4,095

Lease tenure = 5 years

Present value of cash outflows = 4,095 + 4,095 x (PVAF _{11 % , 4} )

= 4,095 + 4,095 x 3.102

= 4,095 + 12,702.69

= $ 16,798

NPV

Purchase option - $ 27,784

Lease option - $ 16,798

Since the present value of cash outflows is lower in case of lease option, hence it is economical to acquire new vehicles on lease.