The Risks of Leasing: The Case of SUVs
On January 1, 2008, Skull Valley Motors leased a Lincoln Navigator to T.K. “Pusan Boots” Denny. The lease is a 3 year lease requiring a payment of $695 at the end of each month for 36 months. The cash price of the Navigator was $46,000. Skull Valley Motors expects to be able to sell the Navigator for $30,652 when it is returned at the end of the 3 year lease term.
1. What interest rate (compounded monthly) was used in the computation of the $695 monthly payment amount?
2. On December 31,2010, Skull Valley Motors learned that the Navigator could be sold for only $25,000 at auction instead of the anticipated $30,652. With this actual residual value, what rate of return (compounded monthly) did Skull Valley earn on this 3 year Navigator lease?
3. Assume that Skull Valley did not know about the decline in residual value until the Navigator was sold at auction for $25,000 in 2010. How much net profit, in total, was recognized during the 3 year life of the lease, excluding the final sale of the Navigator at auction? How much gain or loss was recognized when the Navigator was sold for $25,000 at auction?
4. Refer to (2). If the rate of return on the lease is so low, why would Skull Valley Motors continue in the leasing business at all?