Casey must determine if it is economically preferable to use higher octane gasol

Question

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 $0.220/gallon higher than that of the low octane gas . Casey uses approximately 500gallons 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

Explanation / Answer

Initial Cost = $ 22,000

Interest rate = 8%

Useful life = 9 or 10

Salvage value = $ 0

Total gallons per yea r= 500

If the low octane gasoline price per gallon = $ 1

higher octane gasoline price per gallon = $ 1.20

Total cost of low octane gasoline per year = 1*500 = 500

Total cost of higher octane gasoline per year = 1.20*500 = 600

NPW9 = -22,000 + 500(P/A, 8%, 9)

= -22,000 + 500(6.247)= $ -18,876.50

NPW10 = -22,000 + 600(P/A, 8%, 10)

= -22,000 + 600(6. 71)=$ -17,974

The NPW of higher octane gasoline is less than that of low octane gasoline. So Casey will use higher octane gasoline in his new car.

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