Jimmy Johnson Marginal costs


Marginal costs Jimmy Johnson is interested in buying a new Jeep SUV. There are two options available, a V-6 model and a V-8 model. Whichever model he chooses, he plans to drive it for a period of 5 years and then sell it. Assume that the trade-in value of the two vehicles at the end of the 5-year ownership period will be identical.

There are definite differences between the two models, and Jimmy needs to make a financial comparison. The manufacturer’s suggested retail price (MSRP) of the V-6 and V-8 are $30,260 and $44,320, respectively. Jimmy believes the difference of $14,060 to be the marginal cost difference between the two vehicles. However, there is much more data available, and you suggest to Jimmy that his analysis may be too simple and will lead him to a poor financial decision. Assume that the prevailing discount rate for both vehicles is 5.5% annually. Other pertinent information on this purchase is shown in the following table:

V-6 V-8
MSRP $30,260 $44,320
Engine (liters) 3.7 5.7
Cylinders 6 8
Depreciation over 5 years $17,337 $25,531
Finance charges* over entire 5-year period $5,171 $7,573
Insurance over 5 years $7,546 $8,081
Taxes and fees over 5 years $2,179 $2,937
Maintenance/repairs over 5 years $5,600 $5,600
Average miles per gallon 19 14
Ownership period in years 5 5
Miles driven per year over 5 years 15,000 15,000
Cost per gallon of gas over 5-year ownership $3.15 $3.15

a. Calculate the total “true” cost for each vehicle over the 5-year ownership period.

b. Calculate the total fuel cost for each vehicle over the 5-year ownership period.

c. What is the marginal fuel cost from purchasing the larger V-8 SUV?

d. What is the marginal cost of purchasing the larger and more expensive V-8 SUV?

e. What is the total marginal cost associated with purchasing the V-8 SUV? How does this figure compare with the $14,060 that Jimmy calculated?

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