Question

In: Economics

You are in the market for a new car. With gasoline prices rising, you are looking...

  1. You are in the market for a new car. With gasoline prices rising, you are looking for a gas efficient car. You have narrowed down the choices to two cars.  Prima, a gas efficient car, priced at $25,000, and Malibu, a standard car, which sells for $22,000. You are planning to keep your car for six years. The manufacturer sticker on Prima states that compared to a standard car, Prima will have annual savings of $600.
    1. Assuming your opportunity cost of funds is 8 percent, which car should you purchase? Provide the relevant computations to justify your answer.
    2. Would your decision change if the interest rate is 4 percent?
    3. Would your decision in part a change if the annual savings is $500? Explain.

Solutions

Expert Solution

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.


Related Solutions

If you’ve noticed rapidly rising gasoline prices, what could you infer? A. Gasoline prices have reached...
If you’ve noticed rapidly rising gasoline prices, what could you infer? A. Gasoline prices have reached a new equilibrium. B. Supply for gasoline has surpassed a new high. C. Demand for gasoline is rising. D. The quantity of gasoline bought exceeds the quantity of gasoline sold. Through diversification, investors can reduce _______ risk. A. unsystematic C. systematic B. purchasing power D. all If you wanted to participate in the IPO market, which of the following documents should you study before...
We are looking at the market for gasoline in the United States, this week. Begin with...
We are looking at the market for gasoline in the United States, this week. Begin with the market in equilibrium. A report is released that we should expect the price of gasoline to rise in the near future, with up to a 50-cent increase sometime next week. Assume that we all have access to this information. Graph the changes and answer the following questions: How do the unhappy participants react? Question options: They run home crying They compete with other...
Excess demand leads to a: A) surplus and rising prices. B) shortage and rising prices. C)...
Excess demand leads to a: A) surplus and rising prices. B) shortage and rising prices. C) surplus and falling prices. D) shortage and falling prices.
Are you thinking of bypassing a​ gasoline-fueled car in favor of a hybrid​ (gasoline and​ electric)...
Are you thinking of bypassing a​ gasoline-fueled car in favor of a hybrid​ (gasoline and​ electric) automobile?​ Let's take a look at the relative economics of your possible choice.​ Let's say the​ gasoline-fueled car sells for​$21,000 and gets 25 miles per gallon​(mpg) of​ fuel, while the competing hybrid car sells for ​$26,000 and averages 36.5 mpg. The expected resale value of the hybrid car is $9,100 and that of the​ gasoline-only car is $7,100 after five years of anticipated ownership....
You are looking to purchase a new car with the assistance of a $22,000, five-year loan...
You are looking to purchase a new car with the assistance of a $22,000, five-year loan at an APR of 5.4%, compounded monthly. Required: a. What is the monthly payment on this loan? b. What is the amount of interest and principal on the loan’s first monthly payment? c. What is the amount of interest and principal on the loan’s sixteenth monthly payment? d. Show a second method to determine the amount of interest and principal on the loan’s sixteenth...
You are on the market for a new car. You want to check whether there is...
You are on the market for a new car. You want to check whether there is a significant difference between the fuel economy of mid-size domestic cars and mid-size import cars. You sample 24 domestic car makes and find an average fuel economy of 30.169 MPG with a standard deviation of 4.9556 MPG. For imports, you sample 14 cars and find an average MPG of 36.638 MPG with a standard deviation of 7.6187. Construct a 90% confidence interval for the...
Looking at yesterday’s foreign exchange spot market prices in the Wall Street Journal you notice that...
Looking at yesterday’s foreign exchange spot market prices in the Wall Street Journal you notice that 1.5300 U.S. dollars is equal to 1 British pound and that 1 British pound is equal to 1.3610 European euros. Under these conditions how many U.S. dollars would you need to buy 1 euro? Please show your work so I can learn how you came up with the answer. Thank you so much.
1. If the interest rate is rising and stock prices are simultaneously rising, then according to...
1. If the interest rate is rising and stock prices are simultaneously rising, then according to the fundamental theory of stock pricing There must be irrational agents in the market The expected dividends of firms must be falling The future price of the stock must be falling Expected dividends of firms must be rising 2. Consider the stable growth or steady state model of a stock price. If the price of the stock is $40 per share, the yield on...
Suppose you are in the market for a new car. You identify two models that you...
Suppose you are in the market for a new car. You identify two models that you like and are considering a final purchase decision. The vehicle details are as follows: One is a high fuel efficient vehicle with a fuel cost per mile of $0.10 and the other is a low fuel efficient vehicle with a fuel cost per mile of $0.15. The high efficiency vehicle costs $47,500 in time period 0 (no discounting); the low efficiency vehicle costs $32,500...
Cash flows are end-of-period unless otherwise specified. You are looking to purchase a new car with...
Cash flows are end-of-period unless otherwise specified. You are looking to purchase a new car with the assistance of a $22,000, five-year loan at an APR of 5.4%, compounded monthly. Required: What is the monthly payment on this loan? What is the amount of interest and principal on the loan’s first monthly payment? What is the amount of interest and principal on the loan’s sixteenth monthly payment? Show a second method to determine the amount of interest and principal on...
ADVERTISEMENT
ADVERTISEMENT
ADVERTISEMENT