MIDTERM # 2

You are the owner of an old car, its paint is peeling off but the car is still in good shape and runs smoothly. You now consider two options: 1) give your car a new paint job and keep it for another two years, or 2) buy a new car. You evaluate both options based on an average use of 12,000 Miles per year. Additional parameters for each option are:

Option 1: the new paint job will cost you $ 2,500, your car will need regular maintenance for the next two years which will cost $ 1000/yr, and the car gas consumption is 25 MPG (Miles Per Gallon). After two years you will sell the car for a salvage value of $ 5,000 and use the money as down payment for a new car which will cost $ 30,000 , you will finance the balance through the car dealer at a yearly interest of 7.5% with yearly payments for 5 years (end of year payments). You will keep this new car for ten years, it will require normal maintenance averaging $ 500/yr, and its gas consumption will be 35 MPG, the gas cost is considered $ 3.50 per gallon. At the end of the ten years you will sell the car for $ 4,000.

To simplify the analysis, you may assume that your cost of capital for the first two years running the old re-­?painted car is the same as the cost of capital charged by the car dealer of the new car.

Option 2: you sell the old car without new paint for a salvage value of $ 3,500 and use the money as down payment for a new electric car which will cost $ 40,000, you will finance the balance through the car dealer at a yearly interest of 6.5% with yearly payments for 5 years. You will keep this new car for 12 years, it will require normal maintenance averaging $ 500/yr, and its power consumption will be 5 Miles per kWh, the electric energy rate is $ 0.12 per kWh. At the end of the twelve years you will sell the car for $ 5,000.

QUESTION # 1 -­? Use present value of cost analysis to decide which option is best, and confirm the result using uniform equivalent annual cost QUESTION # 2 – At what gasoline price per gallon would the decision change?