E12-26. Payback Period and NPV of a Cost Reduction Proposal—Differential Analysi

Question

E12-26. Payback Period and NPV of a Cost Reduction Proposal—Differential Analysis Mary Zimmerman decided to purchase a new automobile. Being concerned about environmental issues, she is leaning toward the hybrid rather than the gasoline only model. Nevertheless, as a new business school graduate, she wants to determine if there is an economic justification for purchasing the hybrid, which costs $1,400 more than the regular model. She has determined that city/highway combined gas mileage of the hybrid and regular models are 27 and 23 miles per gallon respectively. Mary anticipates she will travel an average of 12,000 miles per year for the next several years. Required a. Determine the payback period of the incremental investment if gasoline costs $3.60 per gallon E12-26. Payback Period and NPV of a Cost Reduction Proposal—Differential Analysis Mary Zimmerman decided to purchase a new automobile. Being concerned about environmental issues, she is leaning toward the hybrid rather than the gasoline only model. Nevertheless, as a new business school graduate, she wants to determine if there is an economic justification for purchasing the hybrid, which costs $1,400 more than the regular model. She has determined that city/highway combined gas mileage of the hybrid and regular models are 27 and 23 miles per gallon respectively. Mary anticipates she will travel an average of 12,000 miles per year for the next several years. Required a. Determine the payback period of the incremental investment if gasoline costs $3.60 per gallon

Explanation / Answer

Time Hybrid Model RegularModel Incremental Cumulative                                        -                    (1,400.00)                  (1,400.00)                                    1.00                    1,600.00                    1,878.26                        278.26                  (1,121.74)                                    2.00                    1,600.00                    1,878.26                        278.26                     (843.48)                                    3.00                    1,600.00                    1,878.26                        278.26                     (565.22)                                    4.00                    1,600.00                    1,878.26                        278.26                     (286.96)                                    5.00                    1,600.00                    1,878.26                        278.26                          (8.70)                                    6.00                    1,600.00                    1,878.26                        278.26                        269.57 PBP = 5 + 8.70/278.26 PBP = 5.03 Years Particulars Hybrid Model RegularModel Incremental No of Miles                  12,000.00                  12,000.00 Mileage per Gallon                          27.00                          23.00 No of Gallons reqd                        444.44                        521.74 Cost per Gallon                            3.60                            3.60 Total Cost                    1,600.00                    1,878.26                        278.26

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