1.16 NPV Application: Trading in a Car to Save on MPGs
Yossi Kamtzan is considering buying a new car. His current car, which he purchased five years ago, is now ten years old, still in very good condition, but is a terrible gas guzzler. He is considering getting a newer model (used) car in order to save on the high cost of gasoline.
Mr. Kamtzan thinks it would be really cool to own a hybrid vehicle, but cannot find one within his targeted price points; they just have not been in production long enough, and the market for used hybrids is very small. He figures that he will keep the new car for five years before he, again, engages in another trade-in. He cannot figure what it will cost him to trade up again then, so he ignores that consideration in his calculations; he does not think it is relevant anyway. Additionally, he does not think that there will be any material differences in insurance and maintenance costs for the new car. He garages his current vehicle and takes very good care of it, and expects to do the same going forward. He has the cash and will use it to trade up, rather than borrowing.
Does it pay for him to trade in his old car for a newer one with a five-year life? Here are the relevant details.
Value of old car: $5,000
Cost of newer, used car: $20,000
Gas Mileage:
- Old car: 12 MPG
- New car: 25 MPG
- He drives 5,000 miles per year
- Cost of Gasoline: $4 per gallon
This individual may choose to either finance the newer car with cash if has the money or borrow the money if he must or wishes to. We will make a simplifying assumption that the Opportunity Cost of the $15,000 out-of-pocket (cash) newer car expense and the borrowing cost are the same: 6%.
(We shall assume that the borrowing cost of financing the net purchase is the same.)
Use the table below to solve this problem:
Can you imagine a corporation doing a similar (investment) analysis? Provide an example.