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Table 14.3
Year
Costs if Hybrid Bought
Costs if Standard Bought
0
-$27,000
-$22,500
1
-2,000
-2,890
2
-2,000
-2,890
3
-2,000
-2,890
4
-2,000
-2,890
5
-2,000
-2,890
6
-2,000
-2,890
-(Table 14.3) The table shows the initial cost outlays of two versions of the Ford Escape and their estimated annual fuel costs. Stu is not sure whether he wants the hybrid or standard model. Although more expensive, the hybrid model has better gas mileage and would save $890 of gas per year. Assume both cars are worthless after six years. At a 7% interest rate, what is the net present value of the net cost difference between the hybrid and the standard model?

Question

Quizplus · Accepted Answer

To find the net present value (NPV) of the net cost difference, we need to calculate the present value of the costs over the six years. For the hybrid, the initial cost outlay is -$27,000, but it saves $890 of gas per year, which is a net savings of $2,625 over the six years. For the standard version, the initial cost outlay is -$22,500 and it saves nothing on gas. The net cost difference between the two versions is the sum of the initial cost outlay difference and the net gas savings difference, which is -$4,500. To calculate the NPV, we plug in the values into the present value formula: NPV = (-$4,500/1.07) + (-$2,625/1.072) + (-$2,625/1.073) + (-$2,625/1.074) + (-$2,625/1.075) + (-$2,625/1.076) = -$5,143.78. Therefore, the best choice is to buy the standard model since it has a lower net cost over six years (even with the interest rate taken into account).

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