Casey must determine if it is economically preferable to use higher octane gasol
ID: 1198696 • Letter: C
Question
Casey must determine if it is economically preferable to use higher octane gasoline in his new car, The higher octane gas has a cost of $0.220/gallon higher than that of the low octane gas . Casey uses approximately 500gallons of gas per year. He believes that if he uses the higher octane gas , he will extend the life of her car by one year (from a useful life of nine years to a useful life of ten years). His car has an initial cost of $ 22,000 and an assumed salvage value of $0. Given an interest rate of 8% compounded annually, should Casey use the higher octane gasExplanation / Answer
Initial Cost = $ 22,000
Interest rate = 8%
Useful life = 9 or 10
Salvage value = $ 0
Total gallons per yea r= 500
If the low octane gasoline price per gallon = $ 1
higher octane gasoline price per gallon = $ 1.20
Total cost of low octane gasoline per year = 1*500 = 500
Total cost of higher octane gasoline per year = 1.20*500 = 600
NPW9 = -22,000 + 500(P/A, 8%, 9)
= -22,000 + 500(6.247)= $ -18,876.50
NPW10 = -22,000 + 600(P/A, 8%, 10)
= -22,000 + 600(6. 71)=$ -17,974
The NPW of higher octane gasoline is less than that of low octane gasoline. So Casey will use higher octane gasoline in his new car.