Reference no: EM13141116

Scotti, the engineer, is contemplating the acquisition of a 2010 sports car. The negotiated price of the car is $36,750, plus taxes and fees. The purchase price includes a full service and maintenance warranty for 4 years or 50,000 miles, whichever comes first. Scotti needs to decide between leasing the car or purchasing it outright. If purchased, he expects that he will keep the car for 6 years, during which he anticipates that he will be driving an average of 12,000 miles per year, then sell the car or trade it in for a new car. For the purchase option, the taxes and fees amount to an additional $2975, payable upfront. Scotti expects to finance this purchase through a 60-month new car loan offered by the local bank at an 8% simple interest rate. Scotti estimated that the maintenance costs of the purchased car in years 5 and 6 (out of warranty) would be an average of $1,200 and $1,500, respectively (end of year expenses).

The dealer offers a 36-month lease with a 12,000 miles per year allowance. This lease requires a $2,500 initial payment and a $550 monthly payment, with no money due at the end of the lease. To entice Scotti, the dealer cited the advantage of being able to lease a new car of the same brand and model 36 months later for the same price as the current price. The terms of the second lease are the same as those of the first lease (i.e., $550 monthly installment and a $2,500 initial payment, for a 36 month with a 12,000 miles per year allowance.)

Scotti decided that he can afford to draw a $15,000 down payment from his savings account to reduce his monthly payment for the 60-month loan. His savings were barely earning 8% anyhow. He attaches no special value to being able to drive a new leased car in 3 years, but cares about the potential additional maintenance that the purchased car will require once the 4-year warranty has expired.

Scotti decided to use his knowledge in engineering economics and project valuation to determine whether to lease or buy the car. To do so, he proceeded to perform a Present Value analysis, using a spreadsheet, relying on the functions built into Excel.

His analysis involves comparison of three options over a span of 72 months.

1) Taking advantage of the Dealer's offer and signing-up for two sequential leases, 36 months/12,000 miles/year each;

2) Purchasing and selling the car to a private party at the end of the 72-month period at the Kelly Blue Book value of $16,700 (adjusted for inflation);

3) Purchasing and selling the car to the dealer at the end of the 72-month period at the Kelly Blue Book trade-in value of $13,500 (adjusted for inflation).

If you were Scotti:

a) Estimate the monthly payment if the car is purchased with a $15,000 down-payment.

b) Estimate the down-payment required to keep the monthly payment at $550 (the same as the lease monthly payment).

c) Compute the NPW of each option over the 72-month period.

d) Which option is the least costly?