A Decision to Lease or Purchase Vehicles - Assignment Example

? Lease or Purchase Decisions ID# Introduction In order to determine which option is best for the organization in the provision of motor vehicles to use in its operations, it is important to compare the relevant costs for each option. The information in Table 1 in the Appendix indicates that purchasing the vehicles may be the best option. However, insurance is another cost which has not been included in the calculations in Table 1. Additionally, there are other costs including fuel, repairs and maintenance expenses which are yet to be considered. However, since the options relate to the same vehicles they will not impact the option chosen for either vehicle. The options available to the organization is to obtain a lease for 36 months with the option to purchase at the end of the lease period, purchasing the motor vehicles by taking out a loan that is repayable over a 36 month (3 year) period or one that is repayable over a 60 month (5 year) period. The 2013 Odyssey LX There are three alternatives available to the organization if it seeks to purchase a 2013 Odyssey LX as one of the vehicles to be used in carrying out the work of the organization. These vehicles will be mainly assessed based on whether to lease or buy and the repayment period to be chosen in the case of the decision to purchase. The difference in total fixed cost is not very different in the case of the 5 year purchase option and the lease option which are $29,110 and $29,548 respectively and this would make the lease option more attractive in present value terms. The 3 year purchase option is approximately $1,250 less than the 5 year purchase option but the time value of money would determine which the better option. However, other considerations when purchasing a vehicle are its fuel economy and the cost of repairs and maintenance. Option 1 - Lease of the 2013 Odyssey LX for 36 months This option would appear to be the most expensive on the face of it, especially when other factors such as an increase in cost of $0.15 for each additional mile travelled over the 45,000 miles allowed each month. Therefore, an estimation of the total number of miles to be travelled for the first three years of the organization’s operations would have to be taken into consideration. If the total miles to be travelled are well within the 45,000 miles limited then this option may be the best when the present value of money is taken into consideration. Here, an appropriate cost of capital to be used in arriving at the present value of the expenditure over the period would become a further consideration. However, if the motor vehicle is to be purchased by the organization at the end of the lease period approximately half of the total costs to the company of $13,868 would be paid at the end of year 3 and so the present value would be much less than paying the amount over a three year period. Additionally, this option presents the organization with a further option at the end of the lease period to either buy the motor vehicle or lease a new motor vehicle. Therefore, if the organization believes that it is best to get a new vehicle for various reasons including a substantial fall in the value of the vehicle, it would not be saddled with the task of selling the vehicle. One of the drawbacks of this option is that the lessor may specify the type of insurance required and this may place additional and unnecessary burden on the organization. Option 2 – Purchase the Odyssey using a loan repayable over 3 years Purchasing the Odyssey using a loan repayable over 3 years appears to be the lowest cost option based on the information in Table 1. However, this may not be the case if the present value of the expenditure over the 3 year period is considered. As mentioned an appropriate cost of capital would have to be used in determining this. In this case the payments for the motor vehicle are spread evenly over the 3 year period. One advantage of this option is that there will be no further charges for any additional miles travelled over 45,000 as in the case of the lease option. Additionally, the organization has the opportunity of choosing the type of insurance coverage that best suits its needs and will indeed choose one that is most affordable. Furthermore, the company would be able to sell the motor vehicle at any time. Option 3 - Purchase the Odyssey using a loan repayable over 5 years This option would represent a higher cost option than option 2 if the value of money remained the same over time. However, it provides a longer repayment period and so would provide the organization with more funds for fulfilling its monthly expenditures. In fact, the value of money does not remain the same and so it may be a more cost effective means of motor vehicle. As in the case of option 2 the company would also be able to sell the motor vehicle whenever it wishes to do so. The 2013 CRV LX 4WD The same three alternatives are noted in the case of the Odyssey are available for the 2013 CRV LX 4WD. However, the differences in terms of the total annual fixed cost range from $800 to $1,000. See Table 1 for details. Option 1 – Lease the 2013 CRV LX 4WD The same considerations relating to the Odyssey applies in this case and the present value of the expenditure is also of great importance. Option 2 – Purchase of 2013 CRV LX 4WD using a loan repayable over 3 years The same considerations that apply in the case of the Odyssey apply in this scenario. However, the difference in the interest rate used is of importance. The interest rate on the 3 year loan for the Odyssey was 1.9% which in this case is 3.9%. Option 3 - Purchase of 2013 CRV LX 4WD using a loan repayable over 3 years The same considerations also apply in this case as n the case of the Odyssey. However, it should be noted that in the case of the Odyssey the longer term loan commands a higher interest rate than the shorter term loan while in the case of the CRV the rates are the same at 3.9%. This may be indicative of no changes in the risk profile of the CRV after 3 versus 5 years. Conclusion In the case of the 2013 Odyssey LX the most favorable option based on the information contained Table 2 in the Appendix would be to purchase the vehicle using the 5 year loan. However, if the lease option which appears less favorable is chosen then the company will be able to expense the lease rentals and these are deductible for income tax purposes. While the company is able to obtain capital allowances on motor vehicles used in the business the amount is recoverable over a longer period. Additionally, the company may decide to lease another vehicle instead of buying every 3 years. In this case the organization will continue to benefit from general warranty and roadside assistance (See Centennial Honda 2013). Furthermore, comments on Kelly Blue Book (2013) indicate that transmission problems may be encountered. This makes the leasing option even more favorable than leasing and is therefore less risky since transmission problems take a while to show up and would therefore impact resale value. This is definitely less risky than purchasing as this and other problems would impact the resale value of the motor vehicle. However, if the company considers that the total miles travelled annually will substantially exceed the 45,000 miles limit then this should be factored into the decision. Additional factors to consider include the possibility of not been able to recover the book value of the 2013 Odyssey if it is purchased. It should be noted that if the Odyssey is not purchased at the end of the lease period the acquisition fee will not be considered. In the case of the 2013 CRV LX 4WD the 5 year purchase option is the best alternative since the payments in present value terms are substantially less than the other options. See Table 2. Additionally, payment is spread over a longer period and so more cash would be released to deal with other matters. What makes it even more attractive is that the interest rate for the five year purchase option is similar to the 3 year purchase option at 3.9%. This may be an indication that the Honda CRV LX 4WD has a high resale value. Appendix Table 1 2013 Odyssey LX Lease Purchase Payment period 36 months 36 months 60 months Interest rate   1.9% 2.9% Initial cost 25,360.00 25,360.00 25,360.00 Sales tax 784.25 1,648.40 1,648.40 Gross 26,144.25 27,008.40 27,008.40 Amount due at start of lease 442.23     Monthly payment 357.73 773.41 484.92 Initial fee 15.00 15.00 15.00 Annual fee 208.50     Total payments 13,544.01 27,857.76 29,110.20 Lease end value 15,408.40     Acquisition fee 595.00     Total cost 29,547.41 27,857.76 29,110.20   2013 Honda CRV LX 4WD Lease Purchase Payment period 36 months 36 months 60 months Interest rate   3.9% 3.9% Initial cost 23,240.00 25,360.00 25,360.00 Sales tax 794.29 1,510.60 1,510.60 Gross 24,034.29 26,870.60 26,870.60 Amount due at start of lease 447.32     Monthly payment 362.82 731.18 455.66 Initial fee 15.00 15.00 15.00 Annual fee 208.50     Total payments 13,732.34 26,337.48 27,354.60 Lease end value 13,867.95     Acquisition fee 595.00     Grand total 28,195.29 26,337.48 27,354.60 Table 2 - Present value calculations 2013 Odyssey LX Lease PV Factor PV of lease Purchase PV Purchase PV Payment period 36 months   5% 36 months 36 months 60 months 60 months Year 0 15.00 1 15.00 15.00 15.00 15.00 15 Year 1 4501.26 0.952 4,285.20 9,280.92 8,835.44 5,819.04 5539.726 Year 2 4501.26 0.907 4,082.64 9,280.92 8,417.79 5,819.04 5277.869 Year 3 4501.26 0.864 3,889.09 9,280.92 8,018.71 5,819.04 5027.651 Year 4   0.823 0.00   0.00 5,819.04 4789.07 Year 5   0.784 0.00   0.00 5,819.04 4562.127   13518.78   12,271.93 27,857.76 25,286.95 29,110.20 25211.44 Acquisition fee 595 0.864 514.08         Purchase at end of lease 15,408.40 0.864 13,312.86         Total 29522.18   26,098.87 27,857.76 25,286.95 29,110.20 25211.44                 2013 CRV LX 4WD Lease PV Factor PV of lease Purchase PV Purchase PV Payment period 36 months 6% 6% 36 months 36 months 60 months 60 months Year 0 15.00 1 15.00 15.00 15.00 15.00 15.00 Year 1 4562.34 0.943 4,302.29 8774.16 8,274.03 5,467.92 5,156.25 Year 2 4562.34 0.89 4,060.48 8774.16 7,809.00 5,467.92 4,866.45 Year 3 4562.34 0.84 3,832.37 8774.16 7,370.29 5,467.92 4,593.05 Year 4   0.792       5,467.92 4,330.59 Year 5   0.747       5,467.92 4,084.54 13,702.02   12,210.13 26,337.48 23,468.33 27,354.60 23,045.88 Acquisition fee     595.00         Purchase at end     13,867.95         Total 13,702.02   26,673.08 26,337.48 30,838.62 27,354.60 23,045.88 Table 2 - Present value calculations 2013 Odyssey LX Lease PV Factor PV of lease 5% Purchase PV Purchase PV Payment period 36 months     36 months 36 months 60 months 60 months Year 0 15 1 15 15 15 15 15 Year 1 4501.26 0.952 4285.19952 9280.92 8835.436 5819.04 5539.726 Year 2 4501.26 0.907 4082.64282 9280.92 8417.794 5819.04 5277.869 Year 3 4501.26 0.864 3889.08864 9280.92 8018.715 5819.04 5027.651 Year 4   0.823 0   0 5819.04 4789.07 Year 5   0.784 0   0 5819.04 4562.127   13518.78   12271.93098 27857.76 25286.95 29110.2 25211.44 Acquisition fee 595 0.864 514.08         Purchase at end of lease 15,408.40 0.864 13312.8576         Total 29522.18   26098.86858 27857.76 25286.95 29110.2 25211.44                 2013 CRV LX 4WD Lease PV Factor PV of lease 5% Purcahse PV Purchase PV Payment period 36 months 6%   36 months 36 months 60 months 60 months Year 0 15.00 1 15.00 15.00 15.00 15.00 15.00 Year 1 4562.34 0.943 4,302.29 8774.16 8274.0329 5467.92 5156.2486 Year 2 4562.34 0.89 4,060.48 8774.16 7809.0024 5467.92 4866.4488 Year 3 4562.34 0.84 3,832.37 8774.16 7370.2944 5467.92 4593.0528 Year 4   0.792       5467.92 4330.5926 Year 5   0.747       5467.92 4084.5362     12,210.13 26,337.48 23,468.33 27,354.60 23,045.88 Acquisition fee     595.00         Purchase at end of lease     13,867.95         Total     26,673.08 26,337.48 30,838.62 27,354.60 23,045.88 References Centennial Honda (2013). 2013 Honda Odyssey. Retrieved from: http://www.centennialhonda.com/en/newcars/specs/index.spy?make=Honda&model=Odyssey&year=2013 Kelly Blue Book (2013). 2013 Honda Odyssey. Retrieved from: http://www.kbb.com/honda/odyssey/2013-honda-odyssey/ Read More