Cost Management: A Strategic Emphasis 5th Edition by David Stout, Edward Blocher, Gary Cokins

Exercise 31

Cost Planning; Gasoline Prices In June 2008, when gasoline prices were at an all-time high, greater than $4 per gallon, Chrysler Motor Company promoted its Jeep vehicle with the offer of either $4,500 off the price of the vehicle or the guarantee that the buyer would not pay more than $2.99 per gallon of gas for the next three years (the details of the guarantee could vary by dealer).

Required

1. Assume that the Jeep vehicle you are interested in gets 15 mpg combined city/highway and that at the time of purchase you expected gasoline prices to average $5 per gallon over the next three years. How many miles would you have to drive the vehicle in the next three years to make the guarantee more attractive than the $4,500 discount?

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2. Assume the same information as in part 1 above, except the average price of gas for the next three years is not known, but you are likely to drive 8,500 miles per year. What is the breakeven gasoline price in the coming three years so that you would be indifferent between the two options?

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3. What are some important aspects of the decision that do not have to do with the price of gasoline and the $4,500 discount?

Step 1 of 3

1.?Solve for the indifference point in miles (M) where 15 is the mpg, and $2.99 is the guarantee price and $5.00 is the expected price:

Savings for the guarantee       = Savings for the discount

$5 x (M/15) - $2.99 x (M/15) = $4,500 

M = 33,582 miles over three years

If the car buyer expects to drive more than 33,582 miles in three years, or 11,194 miles per year, then the option of the gasoline price guarantee is preferred.