Question

Whispering Pines Golf Club is trying to decide the best course of action for its fleet of new golf carts. Whispering Pines can buy premium tires (today) at a cost of $1,000 per cart. These tires last four years and then must be replaced. The second option is to buy regular tires at a cost of $510 (today) and replace them every two years. It is expected the prices for the tires will not change. A cart is expected to last sixteen years at which time it is replaced. Using a discount rate of 3%, determine the better option for the cost of tires for the sixteen-year economic life of the golf cart.

Answer 1

During the life of 16 years, the number of times tires to be replaced depends on the life of the that model. But for decision making, number of times we replaced is not important. What matters is the present value of the total cash out flow associated with each model during this 16 years of life. That means, we have to select that model which is having lower present value of cash out flow.

Premium tires				Regular tires
Year	CF	DF	PV	Year	CF	DF	PV
4	1000	0.888487	888.49	2	510	0.942596	480.72
8	1000	0.789409	789.41	4	510	0.888487	453.13
12	1000	0.70138	701.38	6	510	0.837484	427.12
16	1000	0.623167	623.17	8	510	0.789409	402.60
				10	510	0.744094	379.49
				12	510	0.70138	357.70
				14	510	0.661118	337.17
				16	510	0.623167	317.82
Present value of cash flow =			3002.44	Present value of cash flow			3155.74

Here, ........... CF means Cash flow and DF means Discounting factor at 3% for respective year ending. PV is the present value obtained as the multiplication of CF * DF.

As seen from the above calculations, it is clear that PREMIUM MODEL is having lower present value for cash out flow. Hence it is recommended as the better option.