Problem 6 (20 points) You are considering buying a new car with a part of your s
ID: 1239773 • Letter: P
Question
Problem 6 (20 points)You are considering buying a new car with a part of your student loan dollars as you really do not need the extra cash now. You have two alternatives with the following cost structures.
Speedy
Initial cost = $20,000
Annual operating cost = $8,000 Useful life = 5 years
Salvage = $2,000
Turbo
Initial cost = $16,000
Annual operating cost = $6,000 Useful life = 4 years
Salvage = $1,500
You want to evaluate these using only economic criteria. Ignore the impact of taxes and you will pay cash for the car.
a. (5 points) Which criterion should you use and why? What are you assuming about implementing the projects when you use this criterion?
b. (10 points) Given that MARR = 10%, which alternative should you choose?
c. (5 points) Assume that MARR is 10%. If you can get a car loan at 8% per year, would you take the loan or use your cash. Economic arguments only here (no numerical answers will be accepted).
Explanation / Answer
a) Consider rate of interest to be same for both:
Cash flows for Speedy
Cash flows for Turbo
Thus, from purely cash flow point of view, buying turbo is more beneficial
b) For MARR = 10%
Cash flows for Speedy:
Cash flows for Turbo:
Rs. -3,073.56
Thus, even for MARR = 10%, he should go for Turbo
c) He should take loan since loan is cheaper than MARR. Future value of his cash will be more than the money spent in repaying loan.
Year 0 1 2 3 4 5 -20,000 -8000 -8000 -8000 -8000 -8000 Salvage 2000 -20,000 -8,000 -8,000 -8,000 -8,000 -6,000 Total Cash flow -58,000