Question

Rondo is in the market for a new car. He has narrowed his search down to 2 models. Model A costs $39,000 and Model B costs $34,000. With both cars he plans to pay cash and own them for 4 years before trading in for a new car. His research indicates that the trade in value for Model A after 4 years is 59% of the initial purchase price, while the trade in value for Model B is 41%. The interest rate is 4%. For simplicity assume that operating and maintenance costs for the models are identical. Which model is the better decision and how much "cheaper" is it than the alternative?

ANSWER: Model A; $2,753.0 (EXPLAIN)

Answer 1

The present value of cost will be calculated for both models. Present value of cost is equal to Initial cost minus Present value of salvage amount. Salvage amount is calculated as percentage of initial cost which are given in problem. NPV factor is calculated as below:

  

Where r is interest rate which is 4% or 0.04

n is number of years which is 4 years.

  

The calculation is explained in following table:

The present value of cost of Model A is $19,326 and model B is $22,081. Thus Model A is cheaper. The difference is calculated as below:

Thus, model A is cheaper by $2,755