Question: Evaluating the Purchase of an Asset with Various Capital Budgeting Methods

In this activity, you will be evaluating whether you should purchase a hybrid car or its gasoline-engine counterpart. Select two car models that are similar, with one being a hybrid model and one being the nonhybrid model. (For example, the Honda Civic is available as a hybrid or a gasoline-engine model.) Assume that you plan to keep your car for ten years and that at the end of the ten years, the resale value of both models will be negligible.

Basic Discussion Questions

1. Research the cost of each model (include taxes and title costs). Also, obtain an estimate of the miles-per-gallon fuel efficiency of each model.

2. Estimate the number of miles you drive each year. Also estimate the cost of a gallon of fuel.

3. Given your previous estimates from 1 and 2, estimate the total fuel cost of driving the hybrid model for one year. Also estimate the total fuel cost of driving the nonhybrid model for one year. Calculate the fuel cost savings offered by the hybrid model over the nonhybrid model.

4. Calculate the NPV of the hybrid model, using the annual fuel savings as the annual cash inflow for the 10 years you would own the car. Assume a required rate of return of 10%.

5. Compare the NPV of the hybrid model with the cost of the gasoline-engine model. Which model has the lowest cost (the lowest NPV)? From a purely financial standpoint, does the hybrid model make sense?

6. Now look at the payback period of the hybrid model. Use the difference between the cost of the hybrid model and the gasoline-engine model as the investment. Use the annual fuel savings as the expected annual net cash inflow. Ignoring the time value of money, how long does it take for the additional cost of the hybrid model to pay for itself through fuel savings?

7. What qualitative factors might affect your decision about which model to purchase?