QUESTION 5.1 Europcar, a leading South African car rental company, wants to determine whether to purchase or lease a fleet of Toyota Yaris motorcars for rental purposes. The company is in the 28% tax...

QUESTION 5.1

Europcar, a leading South African car rental company, wants to determine whether to purchase or lease a fleet of Toyota Yaris motorcars for rental purposes. The company is in the 28% tax bracket and its after-tax cost of debt is currently 7%.

Lease contract

The lease contract determines that the company could lease the fleet of Toyota Quest cars for three years at a lease rental of R295 000 payable at the end of each year. All maintenance costs would be paid by the lessor. Insurance and other costs would be borne by the lessee.

Purchase option

The purchase option allows the company to purchase the fleet of Toyota Quest cars for R900 000 and to finance it entirely with an 11% loan requiring annual end-of-year payment of R368 249 for three years. The fleet would be depreciated by R300 000 per year. Europcar would pay R5 000 per year for a service contract covering all maintenance costs and also bear insurance and other costs.

Europcar’s financial manager asked Tim Joshua for advice as to whether the company should buy or lease the fleet of Toyota Quest cars? To make an informed decision, Tim Joshua compiled an amortisation schedule, and calculated the after-tax cash outflow of the lease contract and the after- tax cash outflow of the borrow-and-buy option.