Question

The CFO of a consulting engineering firm is deciding between purchasing Ford Explorers and Toyota 4Runners for company principals. The purchase price for the Ford Explorer will be $29,750. Annual maintenance costs for the Explorer are expected to be $475 per year more than that of the 4Runner. The purchase price for Toyota 4Runners is 36.250 The trade-in values after 3 years are estimated to be 50% of the first cost for the Explorer and 60% for the 4Runner. (a) What is the incremental ROR between the two vehicles? (b) Provided the firm's MARR is 21% per year, which vehicle should it buy? a) The incremental ROR between the two vehicles is % b) The firm should buy Ford Explorer as the incremental ROR is greater than the MARR.

Answer 1

A.

Incremental initial investment = 36250 - 29750 = $6500

Incremental annual savings = $475

Incremental salvage value = 36250*60% - 29750*50% = $6875

Time = 3 years

Let, incremental ROR = R

Then,

6500 = 475*(1-1/(1+R)^3)/R + 6875/(1+R)^3

At R = 9%

PW of the cash inflows = $6511.13

At R = 10%

PW of the cash inflows = 6346.54

So, as per the method of interpolation,

R = 9% + ((6511.13-6500)/(6511.13-6346.54))*(10%-9%)

R = 9.07%

So, incremental rate of return = 9.07%

B.

Firm should buy Ford Explorer as incremental ROR is less than the MARR.