Ada typically buys a new car and trades in the old one every four years. Because new cars are so expensive, she has recently been considering a change in her buying habits. She would like to know how much she might save in depreciation costs if instead she purchased a new car every five years.

1. Using a new car price of $20,000 and assuming the market value will depreciate by 50 percent over the next four years, calculate the annual cost of depreciation given her present buying habits. Now calculate the annual cost of depreciation under the proposed change. Assume the market value will depreciate by 55 percent over the next five years. What is the Annual cost savings? What is the cost savings over the five-year holding period?

2. What other factors should Ada consider before she changes her buying behavior?

1)
Current Habits - annual cost of depreciation:
(20,000 – 20,000 x (1-.5)) / 4 = $2,500/year
(20,000 – 10,000) / 4 = $2,500/year

Proposed Habits - annual cost of depreciation:
(20,000 – 20,000 x (1-.55)) / 5 = $2,200/year
(20,000 – 9,000) / 5 = $2,200/year

Cost Savings over the 5 years:
Scrap Value Old: $10,000
Scrap Value New: $9,000
Extra Depreciation New: $1,000

2)
Other factors to consider?

Sometimes you can’t get the full car’s worth. You might save more money by keeping the current car for more than 4 or 5 years if maintenance costs remain low.