Payback Period and NPV of alternative automobile purchase Bob Wu decided to purc

Question

Payback Period and NPV of alternative automobile purchase

Bob Wu decided to purchase a new Honda Civic. Being concerned about environmental issues he is leaning toward a Honda civic hybrid rather than the completely gasoline powered LX model. Nevertheless, he wants to determine if there is an economic justification for purchasing the hybrid, which cost $6000 more than the LX. Based on a mix of city and highway driving he predicts that the average gas mileage of each car is 42 mpg for the Hybrid and 30 mpg for the LX. Bob also anticipates he will drive an average of 12,000 miles per year and that gasoline will cost an average of $3.50 per gallon or the next five years. He also plans replace whichever car he purchases at the end of five years when the resale values of the Hybrid and the LX are predicted to be $11,000 and $8,500 respectively.

A) determine the payback period of the incremental investment associate with purchasing the hybrid

B) determine the net present value of the incremental investment associated with purchasing the hybrid at an 8% time value of money

C) determine the cost of gasoline required for a payback period of three years on the incremental investment

D) identify other factors Bob should consider before making his decision

Explanation / Answer

Details Hybrid LX Difference Investment          6,000 Yearly Drive miles           12,000        12,000 Average mileage                    42                 30 Gallons of gasoline required per year             285.71        400.00      114.29 Cost Per Galon of gasoline                3.50             3.50 Yearly Fuel cost        1,000.00     1,400.00            400 Details Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Incremental Investment             (6,000) Incremental Fuel saving              400            400          400         400          400 Incremental resale value      2,500 Net Incremental Cash Flow           (6,000)              400            400          400         400      2,900 PV factor @8%                        1           0.926        0.857      0.794     0.735      0.681 PV of Cash flows             (6,000)              370            343          318         294      1,974 NPV =           (2,701) A Payback period: Payback does not happen within 5 year period. B NPV of the incremental investment = $ (2,701.46) C For required payback within 3 years; Required fuel saving / year=              2,000 Gallon saved in hybrid over LX /year=           114.29 Required Gasoline cost=2000/114.29= $         17.50 So required Gasoline cost for 3 years   payback =$17.50 per Gallon. D Bob should however , consider other factors like environmental effect, cost of spares,   etc for making the purchase decision.

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