In the late 1990s, car leasing was very popular in the United States.  A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car.  If the customer decided to keep the car, the customer would pay a price to the manufacturer, the “residual value,” computed as 60% of the new car price.  The manufacturer would then sell the returned cars at auction.  In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value). Why was the manufacturer losing money on this program? What should the manufacturer do to stop losing money (while still leasing cars)?

Question

In the late 1990s, car leasing was very popular in the United States.  A customer would lease a car from the manufacturer for a set term, usually two years, and then have the option of keeping the car.  If the customer decided to keep the car, the customer would pay a price to the manufacturer, the “residual value,” computed as 60% of the new car price.  The manufacturer would then sell the returned cars at auction.  In 1999, the manufacturer lost an average of $480 on each returned car (the auction price was, on average, $480 less than the residual value).

  • Why was the manufacturer losing money on this program?
  • What should the manufacturer do to stop losing money (while still leasing cars)?

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