7 7 Casey must determine if it is economically preferable to

7

7. Casey must determine if it is economically preferable to use higher octane gasoline in his new car. The higher octane gas has a cost of $0.20/gallon higher than that of the low octane gas. Casey uses approximately 500 gallons of gas per year. He believes that if he uses the higher octane gas, he will extend the life of her car by one year (from a useful life of nine years to a useful life of ten years). His car has an initial cost of $22,000 and an assumed salvage value of $0. Given an interest rate of 8% compounded annually, should Casey use the higher octane gas? (10 points)

Solution

Higher price of octane gas per galon = 0.20

Annual additional cost = 500(0.20) = 100

Benefits:

Depreciation decreases by 22000/9 to 22000/10

= 244.44

Annual interest at 8% will be spread over 10 years instead of 9 years

Total amount payble in 9 years = 43978.10

Per year payment = 4886.46

Total amt payable in 10 years = 47496.35

Per year payment = 4749.63

Difference = 136.83

Total benefits = 136.83+244.44

= 381.27

As benefits per year 381.27 >100 additional cost Casey can use higher Octane gas.