A professor of engineering economics owns a 1996 automobile. In the past 12 months, he has paid $2000 to replace the transmission, bought two new tires for $160, and installed a new tape deck for $110.

A professor of engineering economics owns a 1996 automobile. In the past 12 months, he has paid $2000 to replace the transmission, bought two new tires for $160, and installed a new tape deck for $110. He wants to keep the car for 2 more years because he invested money 3 years ago in a 5-year certificate of deposit, which is earmarked to pay for his dream machine, a red European sports car. Today the old car’s engine failed. The professor has two alternatives. He can have the engine overhauled at a cost of $1800 and then most likely have to pay another $800 per year for the next 2 years for maintenance. The car will have no salvage value at that time. Alternatively, a colleague offered to make the professor a $5000 loan to buy another used car. He must pay the loan back in two equal installments of $2500 due at the end of Year 1 and Year 2, and at the end of the second year he must give the colleague the car. The “new” used car has an expected annual maintenance cost of $300. If the professor selects this alternative, he can sell his current vehicle to a junkyard for $1500. Interest is 5%. Using present worth analysis, which alternative should he select and why?

 

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