Tom Hagstrom has decided to acquire a new car for his business. One alternative is to purchase the car outright for $16,170, financing the car with a bank loan for the net purchase price. The bank loan calls for 36 equal monthly payments of $541.72 at an interest rate of 12.6% compounded monthly. Payments must be made at the end of each month. The terms of each alternative are as follows:
If Tom takes the lease option, he is required to pay $500 for a security deposit, refundable at the end of the lease, and $425 a month at the beginning of each month for 36 months. If the car is purchased, it will be depreciated according to a fiveyear MACRS property classification. The car has a salvage value of $5,800, which is the expected market value after three years, at which time Tom plans to replace the car irrespective of whether he leases or buys. Tom’s marginal tax rate is 35%. His MARR is known to be 13% per year.
(a) Determine the annual cash flows for each option.
(b) Which option is better?