5.

1 The Merrritts New Car Decision: Lease versus Purchase

Karl and Amber Merritt, a dual income couple in their late 20s, want to replace their 7-yearold 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 re-evaluate 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 months 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 cars 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 same 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?

7.2 Aaron Gets His Outback

Aaron Woods, a 27-year old bachelor living in Richmond, Virginia, has been a high-school teacher for 5 years. For the past 4 months hes been thinking about buying a Subaru Outback, but feels he cant afford a brand-new one. Recently, however, his friend Trevor Phillips has offered to sell Aaron his fully loaded Subaru Outback 2.5 XT Limited. Trevor wants $22,500 for his Outback, which has been driven only 7,000 miles and is in very good condition. Aaron is eager to buy the vehicle but has only $8,000 in his savings account at Spider Bank. He expects to net $8,000 from the sale of his Chevrolet Camaro, but this will still leave him about $6,500 short. He has two alternatives for obtaining the money. a. Borrow $6,500 from the First National Bank of Richmond at a fixed rate of 8% per annum, simple interest. The loan would be repaid in equal monthly installments over a 3-year (36 months) period. b. Obtain a $6,500 installment loan requiring 36 monthly payments from the Richmond Teachers Credit Union at a 6.5% stated rate of interest. The add-on method would be used to calculate the finance charges on this loan.

Critical Thinking Questions

1. Using Exhibit 7.5 or a financial calculator, determine the required monthly payments if the loan is taken out at First National Bank of Richmond. 2. Compute (a) the finance charges and (b) the APR on the loan offered by First National Bank of Richmond. 3. Determine the size of the monthly payment required on the loan from the Richmond Teachers Credit Union. 4. Compute (a) the finance charges and (b) the APR on the loan offered by the Richmond Teachers Credit Union. 5. Compute the two loans and recommend one of them to Aaron. Explain your recommendation.