7/27/2019 F1-Hybrid Vehicle case study

1/2

GISE Finance NPV Example

Net Present Value Analysis of the Purchase of a Hybrid Automobile

With high energy costs and the desire to be more environmentally aware the automobile industry has

presented us an increasing number of "hybrids" that may save significant amounts of energy. But

hybrids have a higher price tag than their standard counterparts. This is a situation where NPV analysis is

well suited to determine the value of this additional cost and whether or not the fuel savings really does

provide the required offset.

We are considering this for personal use, so the only revenue that will be provided will be the proceeds

from the sale of the vehicle. Our NPV analysis will focus on the initial purchase, the cost of fuel, and the

resale value. We will make an assumption that the operating costs of hybrid and standard vehicles are

about the same. Therefore, we will ignore the operating costs as they will not provide one vehicle an

advantage over the other.

NPV Analysis

It would be great to look at the Toyota Prius, but because there is no non-hybrid version, it will not serve

our purposes. Rather, we will look at the Honda Civic and the Toyota Highlander.

As with any NPV analysis, we will have to make some assumptions. You drive an average of 1,000 miles a

month and will drive no more or less with either car. Half of your driving is in the city and half is on the

highway. You plan to keep the car five years or 60 months for analysis purposes. We also assume based

on used car sales data, that after five years, you can sell the standard Civic for $7,268 and the hybrid

Civic for $ 8,691. A spreadsheet that illustrates how to compare these two cars has been provided. Note

that there are 60 rows, each representing one month of the use of the cars. The gasoline cost and

mileage figures are held constant, but can easily be changed. We see that at 1,000 miles of driving per

month, the hybrid would use 22.73 gallons per month on average, while the standard Civic would use

30.68 gallons per month on average. For the hybrid, this figure is based on 500 miles at 44 miles a gallon

(11.36 gallons) plus 500 miles at 44 miles a gallon (11.36 gallons) for 22.73 gallons. For the standard, thisfigure is based on 500 miles at 28 miles per gallon (17.86 gallons) plus 500 miles at 39 miles per gallon

(12.82 gallons) for 30.68 gallons. The monthly cost of gasoline would, therefore, be $81.48 for the hybrid

(22.73 x $3.585) and $109.98 (30.68 x $3.585) for the standard.

The cash flows from use of the car are outflows for gasoline, but there is an inflow in the last month in

the form of its expected resale value. The discount rate of 2% has been selected to represent a risk-free

rate since we have not yet discussed risk adjusted discount rates and the analysis that we are doing is on

cash flows due to gasoline purchases. Since we are looking at 2% as an annual rate, we need to convert

to a monthly rate 2.0%/12= 0.167% monthly rate.After calculating all of the monthly present values and summing them up, we see that the present value

of the fuel cost is $4,648 for the hybrid and $6,275 for the standard, a difference of $1,626. This is fairly

small and only about $30 a month during the five-year period. The present value of the resale value is

$8,691 for the hybrid and $7,268 for the standard, an advantage of $1,289 for the hybrid, not much of

an advantage. The total present value advantage to the hybrid is $1,626 + $1,289= $2,915. The hybrid

costs $6,195 more. Hence, the NPV of choosing a hybrid over a standard is $6,195 - $2,915 = -$3,280. In

this case, the hybrid cannot be financially justified.

Of course, a lot of people use the payback method to support their conclusions. This is not the

7/27/2019 F1-Hybrid Vehicle case study

2/2

appropriate method in this instance, but lets see what it tells us. Typically cash flows are not discounted

when using the payback method. Thus, the annual operating differential is easily found given our

simplified example. The cost of fuel for the hybrid is $81.48 a month and for the standard is $109.98, a

difference of $28.50 a month. Thus, at a cost differential of $3,280, it would take $3,280/$28.50 = 217

months or 18 years to recover the cost differential. The resale value would reduce this slightly but not

enough to make a difference. The problem with the payback method is that we have not discounted the

cash flows, and we do not have a benchmark.

There are other factors that enter into the decision. What would make the hybrid favorable?

Questions:

First consider the Civic then consider the Highlander for each question.

1) What about a higher cost of gasoline? How high do gasoline prices have to be to make thehybrid an advantage?

2) How about miles driven? How many miles of driving would make the hybrid more attractive?3) How do the type of miles driven influence the valuation? We are assuming half city and half

highway in the base case.

Now compare the Civic to the Highlander.

4) And how about larger vehicles, does the hybrid have a bigger advantage if the vehicle is larger?