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A cab company is experimenting with various brands of cars as cabs. It has discovered that a higher-priced car attracts more customers, is less expensive to maintain, and loses less maintenance time. The question is whether these advantages justify the higher initial cost. The economic life of cars is 3 years. Explain the answer from the point of view of incremental ( additional ) investment. Use i = 10 % per year.

A cab company is experimenting with various brands of cars as cabs. It has discovered that a higher-priced car attracts more customers, is less expensive to maintain, and loses less maintenance time. The question is whether these advantages justify the higher initial cost. The economic life of cars is 3 years. Explain the answer from the point of view of incremental ( additional ) investment. Use i = 10 % per year.

Essentials Of Investments
Essentials Of Investments
11th Edition
ISBN:9781260013924
Author:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Publisher:Bodie, Zvi, Kane, Alex, MARCUS, Alan J.
Chapter1: Investments: Background And Issues
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A cab company is experimenting with various brands of cars as cabs. It has discovered that a higher-priced car attracts more customers, is less expensive to maintain, and loses less maintenance time. The question is whether these advantages justify the higher initial cost. The economic life of cars is 3 years. Explain the answer from the point of view of incremental (additional) investment. Use i = 10% per year. Justify with calculations. Would appreciate if Excel is not used! ### Table of Car Data | Car | Automobile Price ($) | Salvage Value ($) | Annual Cost of Reparation ($ per year) | Annual Income ($ per year) | |-----|-----------------------|------------------|----------------------------------------|-----------------------------| | 1 | 2,000 | 800 | 630 | 8,000 | | 2 | 2,600 | 1,000 | 550 | 8,300 | | 3 | 3,100 | 1,200 | 540 | 9,000 | | 4 | 4,200 | 1,350 | 460 | 10,100 | | 5 | 6,000 | 2,000 | 300 | 11,000 | ### Explanation of the Table: - **Automobile Price**: Initial purchase cost of the car. - **Salvage Value**: Expected value of the car after 3 years. - **Annual Cost of Reparation**: Yearly maintenance and repair cost. - **Annual Income**: Yearly income generated by the car as a cab. ### Analysis: To determine which car offers the best investment, consider the net present value (NPV) of costs and benefits, using a discount rate of 10%. Compare the differences in investment, operating costs, and revenues for each car. 1. **Initial Investment**: Difference in purchase and salvage value. 2. **Net Annual Cash Flow**: Annual income minus annual cost of reparation. The decision should account for the return on investment by considering both costs and increased revenues from different cars. Calculate the NPV for each car to justify the higher investment in more expensive cars based on the criteria provided.
Transcribed Image Text:A cab company is experimenting with various brands of cars as cabs. It has discovered that a higher-priced car attracts more customers, is less expensive to maintain, and loses less maintenance time. The question is whether these advantages justify the higher initial cost. The economic life of cars is 3 years. Explain the answer from the point of view of incremental (additional) investment. Use i = 10% per year. Justify with calculations. Would appreciate if Excel is not used! ### Table of Car Data | Car | Automobile Price ($) | Salvage Value ($) | Annual Cost of Reparation ($ per year) | Annual Income ($ per year) | |-----|-----------------------|------------------|----------------------------------------|-----------------------------| | 1 | 2,000 | 800 | 630 | 8,000 | | 2 | 2,600 | 1,000 | 550 | 8,300 | | 3 | 3,100 | 1,200 | 540 | 9,000 | | 4 | 4,200 | 1,350 | 460 | 10,100 | | 5 | 6,000 | 2,000 | 300 | 11,000 | ### Explanation of the Table: - **Automobile Price**: Initial purchase cost of the car. - **Salvage Value**: Expected value of the car after 3 years. - **Annual Cost of Reparation**: Yearly maintenance and repair cost. - **Annual Income**: Yearly income generated by the car as a cab. ### Analysis: To determine which car offers the best investment, consider the net present value (NPV) of costs and benefits, using a discount rate of 10%. Compare the differences in investment, operating costs, and revenues for each car. 1. **Initial Investment**: Difference in purchase and salvage value. 2. **Net Annual Cash Flow**: Annual income minus annual cost of reparation. The decision should account for the return on investment by considering both costs and increased revenues from different cars. Calculate the NPV for each car to justify the higher investment in more expensive cars based on the criteria provided.
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