firm is working alongside engineers from Ford Motor Company comparing two SUV mo

Question

firm is working alongside engineers from Ford Motor Company comparing two SUV models to launch for next year’s market. The smaller SUV model will have an initial cost of $22,000, an operating cost of $1,000 per year, and a salvage value of $12,000 after 3 years. The larger SUV model will have initial cost of $26,000, an operating cost of $600 per year, and a salvage value of $15,000 after 3 years. At an interest rate of 15% per year, which model should they launch if they want to save as much money as possible on their investment

Explanation / Answer

We can use present worth method of comparision:

smaller SUV model:

PW = 22,000 + 1000(P/A, 15%, 3) - 12000(P/F, 15%, 3)

      = 22,000 + 1000(2.2832) - 12000(0.6575)

     = 22,000 + 2283.2 - 7890 = $16,393.2

larger SUV model:

PW = 26,000 + 600(P/A, 15%, 3) - 15000(P/F, 15%, 3)

      = 26,000 + 600(2.2832) - 15000(0.6575)

     = 26,000 + 1369.92 - 9862.5 = $17507.42

Here, the PW of smaller SUV model is less and since it is a cost dominated project, thus they should lunch smaller SUV model.

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