Question

Thanks to great PR, hybrid cars have become cool to own (even if they do look like a plastic wedge). What they don’t tell you is that the batteries need to be replaced after extended use. You are trying to decide between either a hybrid Honda Accord or a sporty Mini Cooper S (and once you decide, you will drive that type of car for the rest of your life). The hybrid has a price tag of $25,000, gets 48 miles per gallon of gas, and will last you 8 years. If you get the hybrid, you will need to replace the batteries at the end of the 4th year, which will cost $5,500. The Mini Cooper S will cost you $32,000, gets 32 miles per gallon, and will last you 9 years. You expect to drive 12,000 miles per year. If gasoline currently costs $2.60 per gallon and you expect the price of gasoline to increase by 2% per year, forever, which car should you choose? Assume that you have to pay the full price of the car when you purchase it, the discount rate is 6%, and you pay your gasoline bill at the end of each year (so you will have to pay $2.60 per gallon for the first year you drive the car at the end of the first year).

Answer 1

Accord

Fuel expense in 1st year = (miles driven / miles per gallon) * price per gallon. This expense is increased by 2% each subsequent year.

net present value of this option is calculated using NPV function in Excel. NPV is -$31,314.

Cooper

Fuel expense in 1st year = (miles driven / miles per gallon) * price per gallon. This expense is increased by 2% each subsequent year.

net present value of this option is calculated using NPV function in Excel. NPV is -$36,280

The Accord should be chosen as it has a lower net present value.