E12-26. Payback Period and NPV of a Cost Reduction ProposalDifferential Analysis

Mary Zimmerman decided to purchase a new automobile. Being concerned about environmental issues, she is leaning toward the hybrid rather than the gasoline only model. Nevertheless, as a new business school graduate, she wants to determine if there is an economic justification for purchasing the hybrid, which costs $1,400 more than the regular model. She has determined that city/highway combined gas mileage of the hybrid and regular models are 27 and 23 miles per gallon respectively. Mary anticipates she will travel an average of 12,000 miles per year for the next several years.

Required

a. Determine the payback period of the incremental investment if gasoline costs $3.60 per gallon.

b. Assuming that Mary plans to keep the car five years and does not believe there will be a trade-in premium associated with the hybrid model, determine the net present value of the incremental investment at an eight percent time value of money.

c. Determine the cost of gasoline required for a payback period of three years.

d. At $4.15 per gallon, determine the gas mileage required for a payback period of three years.

Please, show calculations. Thank You!