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Step 1 of 6

There are two alternatives available to own a car. The cost of car is $9,400. The information is
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Lease: We'll send you a one-time
download link
• Monthly lease charge is $267

• Number of monthly payments are 24 888-888-8888 Text me

• After that the car is returned to the company. That means salvage value is zero.

Loan: By providing your phone number, you agree to receive

a one-time automated text message with a link to get
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• Zero down-payment

• Nominal annual interest rate is 12%, and nominal monthly interest rate is 1%

• Number of installments are 24

My Textbook Solutions
• Salvage value at the end of 24 months is $4,700

Calculation of monthly installments:

Here,
Engineering Introduction Introduction
A= the monthly installments = ? Economic... to Chemical... to Chemical...
11th Edition 6th Edition 7th Edition
P= the principal amount = $9,400
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i%=the monthly rate of interest = 1%

n= time period = 24months

Substituting these values in the above equation:

…… (See compound interest table)

Therefore, the monthly installment is $442.74.

Comment

Step 2 of 6

Next step is to calculate the net present worth of the differenced cash flow series and find the
incremental rate of return of this differenced cash flow series. Following table shows the two
alternatives and differenced cash flow series:

Table-1

Months Loan (A) Lease(B) Loan(A)-Lease(B)

1-24 -$442.74 -$267 -$175.74

Salvage value $4,700 0 $4,700

NET PRESENT WORTH OF (ALTERNATIVE A)-(ALTERNATIVE B):

Here,

P= initial costs

A= annual amount that is uniform over the time period

F=future value or salvage value

i= rate of return

n= time period

Comment

Step 3 of 6

In this case, the values are all differenced values and the variables can take the following values:

P= $175.74

A= $175.74

F=$4,700

i= ?

n= 22 for A

23 for F

Comment

Step 4 of 6

Now, substituting the value of variables into the above formula:

…… (1)

Look through the compound interest table and apply trial and error method and find an interest
rate which equalizes equation (1). That is, find an interest rate which equalizes left-hand side and
right-hand side of equation (1).

Substituting the tabular values into the right-hand side of equation (1). The table below shows the
two options whose values are closer to left-hand side of equation (1).

Table-2

Interest Rate (P/A,i,22) (P/F,i,23) Value

1.25% 19.131 0.7515 $184.125

1.50% 18.621 0.7100 $78.325

The rate of return, which is between 1.25% and 1.50%, may indeed be computed by linear
interpolation.

…… (2)

Here,

= lower interest rate

= higher interest rate

= factor of lower interest rate

= factor of higher interest rate

Substituting the values in equation (2), the result is as follows:

 Therefore, the monthly incremental rate of return is 0.01271 or 1.271% (approx.)

Comment

Step 5 of 6

a)

The Annual incremental rate of return is 15.252% (1.271%*12). This suggests that below the
15.252% rate of return, loan (alternative-A) is preferred alternative and after this percentage,
leasing (Alternative-B) is the preferred alternative.

Therefore, over 15.252%, leasing is the preferred alternative.

Comment

Step 6 of 6

b)

Due to following reasons, leasing is more desirable alternative:

• The most important reason is the cost. It is always less expensive to lease a car than it is to
own the car. The people with less disposable income can afford a car using lease alternative.

• In some cases, Leasing is more attractive than buying or taking a loan. In this case also, if the
return from car is above 15.252%, then leasing is the best alternative.

• Some consumers prefer to have the latest cars but not for a long time. Then leasing is the best
alternative for such consumers.

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Recommended solutions for you in Chapter 8

Chapter 8, Solution 34P Chapter 8, Solution 41P

The problem that you have below has to do with There are three options
multiple alternatives that we must decide between. available to buy a new
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