The Riteway Ad Agency provides cars for its sales staff. In thepast, the company has always purchased its cars from a dealer andthen sold the cars after three years of use. The company’s presentfleet of cars is three years old and will be sold very shortly. Toprovide a replacement fleet, the company is considering twoalternatives:

Purchase alternative:

The company can purchase the cars, as in the past, and sell thecars after three years of use. Ten cars will be needed, which canbe purchased at a discounted price of $22,000 each. If thisalternative is accepted, the following costs will be incurred onthe fleet as a whole:

Annual cost of servicing, taxes, and licensing	$	3,800
Repairs, first year	$	1,700
Repairs, second year	$	4,200
Repairs, third year	$	6,200

At the end of three years, the fleet could be sold for one-halfof the original purchase price.

Lease alternative:

The company can lease the cars under a three-year leasecontract. The lease cost would be $57,000 per year (the firstpayment due at the end of Year 1). As part of this lease cost, theowner would provide all servicing and repairs, license the cars,and pay all the taxes. Riteway would be required to make a $14,000security deposit at the beginning of the lease period, which wouldbe refunded when the cars were returned to the owner at the end ofthe lease contract.

Riteway Ad Agency’s required rate of return is 16%.

Click here to view Exhibit 12B-1 and Exhibit 12B-2, to determinethe appropriate discount factor(s) using tables.

Required:    

1. What is the net present value of the cash flows associatedwith the purchase alternative?

2. What is the net present value of the cash flows associatedwith the lease alternative?

3. Which alternative should the company accept?