(Adapted from a problem by S. Zeff.) William Marsh. CEO of Gulf Coast Manufacturing, w ishes to know which of two strategies he has chosen for acquiring an automobile has lower present value of cost.

Strategy L. Acquire a new Lexus, keep it for six years, then trade it in on a new car.

Strategy M. Acquire a new Mercedes-Benz, trade it in after three years on a second Mercedes-Benz, keep that for another three years, then trade it in on a new car.

Data pertinent to these choices appear below. Assume that Marsh will receive the trade-in value in cash or as a credit toward the purchase price of a new car. Ignore income taxes and use a discount rate of 10 percent per year. Gulf Coast Manufacturing depreciates automobiles on a straight-line basis over 8 years for financial reporting, assuming zero salvage value at the end of 8 years.

a. Which strategy has lower present value of costs?

b. What role, if any, do depreciation charges play in the analysis and why?
Lexus Mercedes-Benz Initial Cost at the Start of Year 1 $60,000 $ 45,000 Initial Cost at the Start of Year 4 48,000 Trade-in Value End of Year 3 23,000 End of Year 62 16,000 24,500 Estimated Annual Cash Operating Costs, Except Major Servicing 4,000 4,500 Estimated Cash Cost of Major Servicing End of Year 4 6,500 End of Year 2 and End of Year 5 2,500 ! At this time Lexus is 6 years old; second Mercedes-Benz is 3 years old.