Are you thinking of bypassing a gasolinefueled car in favor of a hybrid (gasolin

Question

Are you thinking of bypassing a gasolinefueled car in favor of a hybrid (gasoline and electric) automobile? Let's take a look at the relative economics of your possible choice. The gasoline-fueled car sells for $20,000 and gets 25 miles per gallon (mpg) of fuel. The alternative hybrid vehicle sells for $24,000 and averages 33.4 mpg. The resale value of the hybrid car is $2,500 more than that of the gasoline-only car after five years of anticipated ownership. If you drive 16,000 miles per year and gasoline costs $4.50 per gallon, what is the internal rate of return on the incremental investment in the hybrid automobile?

Explanation / Answer

Base case: Gasoline fueled car

Savings per year = (16000/25 - 16000/33.4) x 4.5 = $724.311

IRR (on incremental investment) = r

4000 = 724.31/(1 + r) + ... + 724.31/(1 + r)5 +  2500/(1 + r)5

Solve for 'r':

r =12.232%

Year Incremental cost ($) Incremental Cash flows ($) 0 4000 1 724.31 2 724.31 3 724.31 4 724.31 5 2500 + 724.31

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