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Relevant costs

Kristen Lu purchased a used automobile for $8,000 at the beginning of last year and incurred the following operating costs:

Depreciation ($8,000 5 years) . . . . . . . . . $1,600
Insurance . . . . . . . . . . . . . . . . . . . . . . . . . . . $1,200
Garage rent . . . . . . . . . . . . . . . . . . . . . . . . . $360
Automobile tax and license . . . . . . . . . . . . . $40
Variable operating cost. . . . . . . . . . . . . . . . . $0.14 per mile

The variable operating cost consists of gasoline, oil, tires, maintenance, and repairs. Kristen estimates that, at her current rate of usage, the car will have zero resale value in five years, so the annual straight-line depreciation is $1,600. The car is kept in a garage for a monthly fee.
Required:
1. Kristen drove the car 10,000 miles last year. Compute the average cost per mile of owning and operating the car.
2 Kristen is unsure about whether she should use her own car or rent a car to go on an extended cross-country trip for two weeks during spring break. What costs above are relevant in this decision? Explain.
3. Kristen is thinking about buying an expensive sports car to replace the car she bought last year. She would drive the same number of miles regardless of which car she owns and would rent the same parking space. The sports car's variable operating costs would be roughly the same as the variable operating costs of her old car. However, her insurance and automobile tax and license costs would go up. What costs are relevant in estimating the incremental cost of owning the more expensive car? Explain.

Solution Preview

1. The average cost = average fixed cost per mile + variable cost per mile
The variable cost = 0.14 per mile
Total fixed cost = 1,600+1,200+360+40 = 3,200
Fixed cost per mile = 3,200/10,000 miles = 0.32
Average ...

Solution Summary

The solution explains the relevant costs in replacing the car

$2.19