Question #275857

Tom Jackson is buying a new car. Alternative A is an American-built compact. It has an initial cost of

$8900 and operating costs of 9cents /km, excluding depreciation. From resale statistics, Tom estimates

the American car can be resold at the end of 3 years for $1700.Alternative B is a foreign-built Fiasco.

Its initial cost is $8000, the operating cost, also excluding depreciation, is 8 cents /km. How low could

the resale value of the Fiasco be to provide equally economical transportation? Assume Tom will drive

12,000 km/year and considers 8% as an appropriate interest rate.

Expert's answer

Salvage Value: It is called the Resale value of any asset at the end of life of an asset.

Calculation of Equivalent Annual Cost for Alternative A is given below:

Given:

Alternative A:

Initial Cost = $8,900

Operating Costs = 9/km or 0.09

Time = 3 years

Resale(salvage) value = $1,700

Interest rate = 8%

Tyrella will drive = 12,000 km/year

Where,

P = Initial cost

S = Salvage value

EAC of Alternative A:

Computation of Equivalent Annual Cost for Alternative B is given below:

Given:

Alternative B:

Initial Cost = $8,000

Operating Costs = 8/km or 0.08

Time = 3 years

Resale(salvage) value = ?

Interest rate = 8%

Tyrella will drive = 12,000 km/year

EAC of Alternative B:

Computation of Salvage value for Alternative B is given below:

EAC of Alternative A = $4009.6

EAC of Alternative B = $4063 – 0.3080S

Equating both EAC of A and EAC of B we get,

Hence, the Resale value(Salvage value) for Alternative B i.e. Fiasco will be $176.62 for providing economical transportation equally.

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