Calculate the net values at the ends of the branches

Assignment Help Microeconomics
Reference no: EM131523791

Question: When you purchase a car, you may consider buying a brand-new car or a used one. A fundamental trade-off in this case is whether you pay repair bills (uncertain at the time you buy the car) or make loan payments that are certain. Consider two cars, a new one that costs $15,000 and a used one with 75,000 miles for $5,500. Let us assume that your current car's value and your available cash amount to $5,500, so you could purchase the used car outright or make a down payment of $5,500 on the new car. Your credit union is willing to give you a five-year, 10% loan on the $9,500 difference if you buy the new car; this loan will require monthly payments of $201.85 per month for 5 years. Maintenance costs are expected to be $100 for the first year and $300 per year for the second and third years. After taking the used car to your mechanic for an evaluation, you learn the following. First, the car needs some minor repairs within the next few months, including a new battery, work on the suspension and steering mechanism, and replacement of the belt that drives the water pump. Your mechanic has estimated that these repairs will cost $150. Considering the amount you drive, the tires will last another year but will have to be replaced next year for about $200. Beyond that, the mechanic warns you that the cooling system (radiator and hoses) may need to be repaired or replaced this year or next and that the brake system may need work.

These and other repairs that an older car may require could lead you to pay anywhere from $500 to $2,500 in each of the next 3 years. If you are lucky, the repair bills will be low or will come later. But you could end up paying a lot of money when you least expect it. Draw a decision tree for this problem. To simplify it, look at the situation on a yearly basis for 3 years. If you buy the new car, you can anticipate cash outflows of 12 × $201.85 = $2,422.20 plus maintenance costs. For the used car, some of the repair costs are known (immediate repairs this year, tires next year), but we must model the uncertainty associated with the rest. In addition to the known repairs, assume that in each year there is a 20% chance that these uncertain repairs will be $500, a 20% chance they will be $2,500, and a 60% chance they will be $1,500. (Hint: You need three chance nodes: one for each year!) To even the comparison of the two cars, we must also consider their values after 3 years. If you buy the new car, it will be worth approximately $8,000, and you will still owe $4,374. Thus, its net salvage value will be $3,626. On the other hand, you would own the used car free and clear (assuming you can keep up with the repair bills!), and it would be worth approximately $2,000. Include all of the probabilities and cash flows (outflows until the last branch, then an inflow to represent the car's salvage value) in your decision tree. Calculate the net values at the ends of the branches.

Reference no: EM131523791

Reviews

Write a Review

 

Microeconomics Questions & Answers

  Firms marketing and pricing policies

Compute the elasticities for each variable. On this basis, discuss the relative impact that each variable has on the demand. What implications do these results have for the firm's marketing and pricing policies?

  Determine the effects of government intervention

ECO 202 Final Project - Determine the effects of government intervention and fiscal and monetary policy actions for their impact on the economy

  Explain what is strategic management and planning why would

select a small business that you may want to start. jeans company or human resource consulting firmdescribe what is

  Select an article from any australian news websites

Select an article from any Australian news websites or newspapers(e.g. Financial Review, The Age, and Sydney Morning Herald). Ensure that the article you choose contains news/information/description about: (a) Competition and the nature of competitiv..

  Define the price floor

Suppose that the federal government places a binding price floor on chocolate. To help support the price floor, the government purchases all of the leftover.

  By how much equilibrium changes to occur at new target rate

Also, assume that the current Federal funds rate is at the 3 percent rate that is targeted by the Fed. Now suppose that the Fed retargets the rate to 1.5 percent. By how much will the quantity of Federal funds have to change for the equilibrium to ..

  Draw an aggregate production function with typical shape

draw an aggregate production function with typical shape and label it f. make sure to label the axis of the graph. now

  What kind of activities might prevent this from happening

One of the potential negative consequences of both economic and population growth is that we will eventually exhaust the Earth's natural resources.

  Examine the effects of each of the given on national saving

analyze the effects of each of the following on national saving investment and the real interest rate. explain your

  What price and quantity will monopolist produce at if

suppose that a firm has a monopoly on a good with the following demand schedulequantity price0 101 92 83 74 65 56 47 38

  Identify basic elements of a real-estate investor decision

Imagine the difficulties of an employer whose decision context is choosing a new employee from a set of applicants whom he will interview.

  Why is it significant to consider uncertainty when

by outsourcing overseas a company can reduce costs but must also take certain risks. global supply chains are exposed

Free Assignment Quote

Assured A++ Grade

Get guaranteed satisfaction & time on delivery in every assignment order you paid with us! We ensure premium quality solution document along with free turntin report!

All rights reserved! Copyrights ©2019-2020 ExpertsMind IT Educational Pvt Ltd