Payback Period and NPV of a Cost Reduction ProposalDifferential Analysis

Hermione 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 $2,200 more than the regular model. She has determined that city/highway combined gas mileage of the hybrid and regular models are 40 and 30 miles per gallon respectively. Hermione anticipates she will travel an average of 15,000 miles per year for the next several years.

(Round your answers to two decimal places.)

(a) Determine the payback period of the incremental investment if gasoline costs $2.60 per gallon. Answer

years

(b) Assuming that Hermione plans to keep the car about six 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 6% time value of money. (Use a negative sign with your answer.) $Answer

(c) Determine the cost of gasoline required for a payback period of four years. $Answer

per gallon

(d) At $4.00 per gallon, determine the gas mileage required for a payback period of four years. Answer

miles per gallon