Karl and Amber Merritt, a dual-income couple in their late 20s, want to replace their 7-year-old car, which has 90,000 miles on it and needs some expensive repairs. After reviewing their budget, the Merritts conclude that they can afford auto payments of not more than $350 per month and a down payment of $2,000. They enthusiastically decide to visit a local dealer after reading its newspaper ad offering a closed-end lease on a new car for a monthly payment of $245. After visiting with the dealer, test-driving the car, and discussing the lease terms with the salesperson, they remain excited about leasing the car but decide to wait until the following day to finalize the deal. Later that day the Merritts begin to question their approach to the new car acquisition process and decide to carefully reevaluate their decision.

Critical Thinking Questions 

1. What are some basic purchasing guidelines the Merritts should consider when choosing which new car to buy or lease? How can they find the information they need? 

2. How would you advise the Merritts to research the lease-versus-purchase decision before visiting the dealer? What are the advantages and disadvantages of each alternative? 

3. Assume the Merritts can get the following terms on a lease or a bank loan for the car, which they could buy for $17,000. This amount includes tax, title, and license fees. 

• Lease: 48 months, $245 monthly payment, 1 month’s payment required as a security deposit, $350 end-of-lease charges; a residual value of $6,775 is the purchase option price at the end of the lease. 

• Loan: $2,000 down payment, $15,000, 48-month loan at 5% interest requiring a monthly payment of $345.44; assume that the car’s value at the end of 48 months will be the same as the residual value and that sales tax is 6%. The Merritts can currently earn interest of 3% annually on their savings. They expect to drive about the same number of miles per year as they do now. 

a. Use the format given in Worksheet 5.1 to determine which deal is best for the Merritts. 

b. What other costs and terms of the lease option might affect their decision? 

c. Based on the available information, should the Merritts lease or purchase the car? Why?  

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AUTOMOBILE LEASE VERSUS PURCHASE ANALYSIS* Name Elaine Hodges Item Description LEASE 1 Initial payment: a. Down payment (capital cost reduction): b. Security deposit: 2 Term of lease and loan (years)* Date April 7, 2011 Amount $2,200.00 500.00 $ 2,700.00 3 Term of lease and loan (months) (Item 2 x 12) 4 Monthly lease payment 5 Total payments over term of lease (Item 3 Item 4) 6 Interest rate earned on savings (in decimal form) 7 Opportunity cost of initial payment (Item 1 x Item 2 Item 6) 8 Payment/refund for market value adjustment at end of lease ($0 for closed-end leases) and/or estimated end-of-term charges 9 Total cost of leasing (Item 1a + Item 5+ Item 7 + Item 8) +1 PURCHASE 10 Purchase price 11 Down payment 48 $ 350.00 $16,800.00 0.040 432.00 0.00 19.482.00 $22,000.00 $3,500.00 12 Sales tax rate (in decimal form) $ 0.05 13 Sales tax (Item 10 x Item 12) $1,100.00 14 Monthly loan payment (Terms: 18,500.00, 48 months, %) 15 Total payments over term of loan (Item 3 x Item 14) 443.01 $21,264.27 16 Opportunity cost of down payment (Item 2 x Item 6 x Item 11) 17 Estimated value of car at end of loan $ 560.00 $ 12,100.00 18 Total cost of purchasing (Item 11+ Item 13 + Item 15+ Item 16 - Item 17) DECISION $14,324.27 If the value of Item 9 is less than the value of Item 18, leasing is preferred; otherwise the purchase alternative is preferred.