When you buy your new car, you are offered a $1,000. maintenance contract that w

Question

When you buy your new car, you are offered a $1,000. maintenance contract that will cover all repair costs for five years on the car. You estimate the following repair expenses for the car:

Year 1: 0

Year 2: $100.

Year 3: $250.

Year 4: $500.

Year 5: $750.

If you could also make an investment with an 8.00% return for five years, would you buy the maintenance contract or invest your money? Determine the Present Value of the maintenance contract, based on an 8.00% rate of return: $1,162.14. Therefore you would buy the contract assuming you'll keep the car for five years since the present value of future payments is greater than the present value of the alternative investment at 8%, i.e., $1000.

WITHOUT USING EXCEL

Explanation / Answer

PV of repair expenses

= 100/1.08^2 + 250/1.08^3 + 500/1.08^4 + 750/1.08^5

= 1162.14

since the present of future paymnets is greater than maintainance contract

hence should buy the maintainance contract

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