Least-Cost Investment Decision

You are considering the purchase of a new vehicle. There are two options for the auto acquisition: a traditional gas-powered auto or a hybrid auto. Based on the information provided below and using net present value (NPV), you will be evaluating the two options and making a recommendation. Note: this scenario is a least cost decision. Since the decision to buy a car will only involve costs, you will be choosing the option with the highest NPV (which in this case, will be the project with the LEAST negative NPV). The assumed WACC is 10%.

Traditional Gas-Powered Auto:

Project Life: The autos are going to be kept for 7 years before being sold.

Cost of Auto: $18,000

Annual Maintenance Cost: Each year, maintenance costs will be a fixed $300.

Gas Cost: The cost of gas is estimated to be an average of $3.30 per gallon over the next 7 years. The auto gets an average of 30 miles to the gallon. The auto is to be driven 16,000 miles per year.

Salvage Value: The car has an estimated salvage value of $4,000 at the end of 7 years.

Hybrid Auto:

Project Life: The autos are going to be kept for 7 years before being sold.

Cost of Auto: $24,000

Annual Maintenance Cost: Each year, maintenance costs will be a fixed $450 (hybrid maintenance costs are higher due to more complex technology).

Gas Cost: The cost of gas is estimated to be an average of $3.30 per gallon over the next 7 years. The auto gets an average of 55 miles to the gallon. The auto is to be driven 16,000 miles per year.

Salvage Value: The car has an estimated salvage value of $7,000 at the end of 7 years.

Tax Credit: The US government encourages the purchase of more fuel-efficient autos, and has offered a $1,000 tax credit in the year of purchase of a qualifying vehicle. Note: The tax credit represents a cash inflow, as it represents cash saved on taxes. Assume the tax credit is taken at the END of the first year of ownership.

Required:

1. Calculate the NPV for both auto purchases.
2. Make a recommendation for which car you would purchase.
3. Assume gas prices rise to an average of $4.50 per gallon. Recalculate the NPVs and make a recommendation.