In: Economics
Prima Car |
Malibu Car |
|
Initial Cost |
$25,000 |
$22,000 |
Annual Savings |
$600 |
Nil |
Life |
6 years |
6 years |
a. Assuming your opportunity cost of funds is 8 percent, which car should you purchase? Provide the relevant computations to justify your answer.
If the rate of interest is 8%, calculate the PW of Prima Car
PW = $25,000 - $600 (P/A, 8%, 6)
PW = $25,000 - $600 (4.6229) = 22,226.26
Price of Malibu Car is $22,000, which less than the PW of Prima car. Therefore, Malibu Car should be purchased.
b. Would your decision change if the interest rate is 4 percent?
If interest rate is 4%, again calculate the PW of Prima Car
PW = $25,000 - $600 (P/A, 4%, 6)
PW = $25,000 - $600 (5.2421) = $21,854.74
Now, it is better to purchase the Prima Car, because their cost is less than of the Malibu Car. The price of Malibu Car is 22,000 but after compensating the savings, the price of Prima Car is $21,854.74. Therefore, Prima Car should be purchased.
c. Would your decision in part a change if the annual savings is $500? Explain.
If the savings becomes $500 and rate of interest is 8%, then the PW of Prima Car will be
PW = $25,000 - $500 (P/A, 8%, 6)
PW = $25,000 - $500 (4.6229) = 22,688.55
Price of Malibu Car is $22,000, which again less than the PW of Prima car. Therefore, Malibu Car should be purchased. Decision in the part (a) does not change. Even if the annual savings is 500, Malibu Car should be purchased.