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Least-Cost Investment Decision

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

Traditional Gas-Powered Auto:

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

Cost ofAuto: $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 gallonover the next 7 years. The auto gets an average of 30 miles to thegallon. The auto is to be driven 16,000 miles per year.

SalvageValue: 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 bekept for 7 years before being sold.

Cost ofAuto: $24,000

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

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

SalvageValue: 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-efficientautos, and has offered a $1,000 tax credit in the year of purchaseof a qualifying vehicle. Note: The tax credit represents a cashinflow, as it represents cash saved on taxes. Assume the tax creditis taken at the END of the first year of ownership.

Required:

Calculate the NPV for both auto purchases.

Make a recommendation for which car you would purchase.

Assume gas prices rise to an average of $4.50 per gallon.Recalculate the NPVs and make a recommendation.

Traditional Gas-Powered Auto

$ Amount

PV Factor

PV of Cash Flow*

Cost of Auto

Maintenance per Year

Cost of Gas per Year

Salvage Value

Net Present Value

0

* Remember to make cash outflows negative and inflowspositive

Hybrid Auto

$ Amount

PV Factor

PV of Cash Flow*

Cost of Auto

Tax Credit

Maintenance per Year

Cost of Gas per Year

Salvage Value

Net Present Value

0

3. Gas at 4.50

Traditional Gas-Powered Auto

$ Amount

PV Factor

PV of Cash Flow*

Cost of Auto

Maintenance per Year

Cost of Gas per Year

Salvage Value

Net Present Value

0

* Remember to make cash outflows negative and inflowspositive

Hybrid Auto

$ Amount

PV Factor

PV of Cash Flow*

Cost of Auto

Tax Credit

Maintenance per Year

Cost of Gas per Year

Salvage Value

Net Present Value

0

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Tod Thiel
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28 Sep 2019

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ACC 600 IMBA Case 2

Situation 1

Honest Al’s Auto Dealer purchases used cars at auto auctions andsells them retail. The autos, on average, sell for approximately$15,000 each and cost Al $11,000. The costs that the company incursin a typical month are listed below:

Costs Cost Formula

Selling:

Advertising $2,500 per month

Preparation of AutosforDelivery $175 per auto sold

Sales salaries &commissions $3,500 per month, plus 5% of sales

Utilities $3,000 per month

Depreciation on salesfacility $4,000 per month

Administrative:

Executivesalaries $15,000 per month

Depreciation onofficeequipment $2,400 per month

Clerical $3,200 per month

Insurance $900 per month

During June, Honest Al’s sold 38 autos.

Prepare a traditional income statement for June.

Prepare a contribution format income statement for June.Showcosts and revenues on both a total and per unit basis down throughcontribution margin.

For the statement you prepared for Part 2, why might it bemisleading to show the fixed costs on a per unit basis?

Situation 2

Fly-by-Night, Inc. is strapped for cash for investment projectsand must decide which of four projects it will fund. Below are theprojects and information about them:

Life of

Net the Internal

Investment Present Project Rate of

Project Required Value* inYears Return

1 $800,000 $221,615 7 18%

2 $675,000 $210,000 12 16%

3 $500,000 $175,175 7 20%

4 $700,000 $152,544 3 22%

*A 10% discount rate was used to compute the net presentvalue.

Required

Compute the project profitability index for each project .

Fly-by-Night wants to rank the projects first, second, third,and fourth based on each of the following:

Rank the four projects in order of preference in terms of :

Internal rate of return

Project profitability index

Net present value.

Which of the three rankings above do youprefer and what are thestrengths and weaknesses of each?

Situation 3

Much has been written about the value chain.Find and summarize (not copy) an article on thissubject. Cite the author and the publication using APA style. Yoursummary should be at least 200 words long. Give the meaning of theterm value chain and identify a businessorganization that employs this concept.

Payback Period and NPV of a Cost Reduction Proposal—Differential 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 $1,595 more than the regular model. She has determined that city/highway combined gas mile-

age of the hybrid and regular models are 30 and 24 miles per gallon respectively. Hermione 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 $2.75 per gallon.

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 incre-

mental investment at six percent time value of money.

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

d. At $4.60 per gallon, determine the gas mileage required for a payback period of three years.

(130 Points)

Q1. A friend of mine is graduating soon. She accepted a job offer where she will be living away

from her family for the next couple of years. She is in the market looking for a new car and she

needs your help in order to decide whether to buy or lease. Since she does not know yet if she is

going to stay in the new job or not, she wants a short term commitment, two to three years.

She is currently looking at the 2018 Toyota Corolla. Based on the following information and the

fact that her opportunity cost is 6%, your recommendation to buy or lease is needed if the decision

is over two or three years. A detailed and complete analysis is required to support your claims.

New 2018 Corolla LE Lease –

$179 per Month / 36 Months / $2,878 Due at Signing

OFFER DETAILS

For well-qualified lessees with approved credit through Southeast Toyota Finance. Not all

lessees will qualify for this payment amount. Closed-end lease on new 2018 Corolla LE model #

1852 with automatic transmission and select equipment. Adding options increases payment.

$179.00 per month for 36 months. $2,878 due at signing includes $2,699 down payment and first

month's payment. No security deposit required. $17,582 Adjusted Capitalized Cost is based on

down payment; excludes tax, tag, registration, title and dealer fees. Dealer fees vary by dealer.

Monthly payments do not include applicable taxes. Lessee pays the remainder of maintenance

after ToyotaCare expires, excess wear and use, and $0.18 per mile over 12,000 miles per year.

Lease payments total $6,444. Disposition Fee of $350 due at lease-end. May not be combined

with certain other offers. Must take delivery between 06/05/18 and 07/09/18.

Assume that the same offer details above apply for 36 month lease and the mileage limit is 36,000

miles, but she won’t go above the mileage limit.

The MSRP for New 2018 Corolla LE is $20,897 (do not worry about taxes). She applied for an

auto loan and was able to get 1.99% APR compounded monthly for 24 or 36 months. Auto loan

payments are due the end of the month, while lease payments are due the first day of each month.

No down payment required to purchase the car.

COST TO OWN A 2018 TOYOTA COROLLA State:

Miles Driven Annually: 12,000

Cost to Own Breakdown Year by

Year: Year 1 Year 2 Year 3 Year 4 Year 5 Total

Depreciation $4,675 $1,235 $1,164 $1,038 $889 $9,002

Maintenance $0 $0 $135 $111 $812 $1,057

Repairs $0 $0 $0 $706 $918 $1,625

Every new vehicle purchased or leased includes complementary maintenance and roadside

assistance for 2 years or 25,000 miles.

Based on the KBB, the following will be the fair value of the car for different parties in 24-month

and 36-month.

In 24-Month In 36-Month

Retail Value $15,518 $14,967

Trade-In $12,418 $11,967

Private Value $13,518 $13,017

Note: The dealership will sell you a used car at the Retail Value, but buy it from you at the Trade-

In value. If you decided to sell your car by yourself to a private party, you will receive the private

value.

Hint: The main goal of this project is to see whether you understand the concept of Time Value of

Money (TVM), we covered in Chapter 4. TVM is the most important principle in the world of

finance, and I have to make sure you understand that money has different values over time

depending on the required interest rate. In other words, it is not simply adding or subtracting

numbers (a dollar today is not equivalent to a dollar tomorrow). Therefore, you need to create a

time line for each option, buy vs. lease, and for each period, 24 vs. 36 mo. On this time line, you

have to include all projected monthly payments based on the provided information. Once you have

all the payments on your time line, you can now discount them (calculate the present value) back

to period t=0 and compare your options. Feel free to use spreadsheets if you like to do it this way.

Finally, before you email or call me with your questions, you need to review Ch. 4 carefully. I may

give hints, but I will NOT solve the project for you!

- A detailed and complete analysis for the problem is required. Excel spreadsheets,

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