Payback Period and NPV of Alternative Automobile Purchase

Bob Wu decided to purchase a new Honda Civic. Being concerned about environmental issues

he is leaning toward a Honda Civic Hybrid rather than the completely gasoline-powered LX

model. Nevertheless, he wants to determine if there is an economic justification for purchasing

the Hybrid, which costs $6,000 more than the LX. Based on a mix of city and highway driving he

predicts that the average gas mileage of each car is 40 MPG for the Hybrid and 30 MPG for the

LX. Bob also anticipates he will drive an average of 12,000 miles per year and that gasoline will

cost an average of $3.75 per gallon over the next five years. He also plans to replace whichever

car he purchases at the end of five years when the resale values of the Hybrid and the LX are

predicted to be $11,000 and $8,500 respectively.2

Required

a. Determine the payback period of the incremental investment associated with purchasing the

Hybrid.

b. Determine the net present value of the incremental investment associated with purchasing

the Hybrid at an eight percent time value of money.

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

tal investment.

d. Identify other factors Bob should consider before making his decision