Question

You are trying to decide between taking the bus to work or buying a car and driving. Assume that a bus pass costs $100/month but that when you use the bus you also need to take a taxi to/from the bus stop at an additional cost of $120/month. You can buy a good used car for $5000. It will last for 5 years and be worthless at the end of that time. In addition, gas and parking cost $125/month. Your cost of capital is 5% (EAR).

Which should you choose, bus or car?

Answer 1

Answer-

First Option

For 5 years

Bus pass costs = $ 100 / month
taxi from the bus stop costs = $ 120 / month

Total cost = $ 100 + $120 = $ 220 / month

Cost incurred in 5 years = $ 220 x 5 x 12 = $ 13200

Second Option

Cost of car = $ 5000
Salvage value = $ 0

Cost of Capital = 5 %
Future value in 5 years = $ 5000 x ( 1 + r )^T   

Future value in 5 years = $ 5000 x ( 1+ 0.05)⁵

Future value in 5 years = $ 5000 x 1.05⁵ = $ 5000 x 1.2763 = $ 6381.5

Gas and parking costs = $ 125 / month

Gas and parking costs in 5 years = $ 125 x 5 x 12 = $ 7500

Total cost is Seond option = $ 6381.5 + $ 7500 = $ 13881.5

It would be better to use a bus and rather thaan buying a car as the cost incurred in 5 years is equal to $ 13881.5 for car than using a bus to travel which incurs $ $ 13200

The cost will be higher by $ 13881.5 - $ 13200 = $ 681.5 when using a car and driving over bus.

Therefore taking the bus to work is more preferable than buying a car and driving. One should choose the bus.