In this Capital Budgeting 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 non-hybrid model. For example, the Honda Civic is available as a hybrid or a gasoline-engine model. Use the Federal Reserve Bank Prime Loan rateLinks to an external site. for your discount interest rate. Assume that you plan on keeping your car for 10 years and that the resale value of both models will be negligible. Assume the loan period is for 10 years as well.
- Research the cost of each model (include estimated taxes and title costs). Also, obtain an estimate of the miles-per-gallon fuel efficiency of each model.
- Estimate the number of miles you drive each year. Also, estimate the costs of a gallon of fuel.
- Given your previous estimate from 1 and 2, estimate the total cost of driving the hybrid model for one year. Also, estimate the total cost of driving the non-hybrid model for one year. Calculate the savings offered by the hybrid model over the non-hybrid model.
- 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.
- Compare the NPV of the hybrid model with cost of the cost of the gasoline-engine model. Which model has the lowest NPV? From a financial standpoint, does the hybrid model make sense?
- 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?
- What qualitative factors might affect your decision about which model to purchase?