Question

The Man must replace the tires on his Chrysler LeBaron. Standard tires cost $600 and last three years, but premium tires cost $800 and last four years. What should the Dude do? His discount rate is 10%.

1. Buy the standard tires.
2. Buy the premium tires.
3. Don't replace the tires.
4. Brake hard on entrance ramps, get rear-ended, total the car and collect insurance.

Answer 1

Ans:

Standard Tyre Cost : $600

Life : 3 Years

Discount Rate : 10%

Annuity Factor @10% for 3 Years : 1/(1.10)^1 + 1/(1.10)^2 + 1/(1.10)^3 : 2.486852

Effective Annual Cost : Standard Tyre Cost / Annuity Factor

= $600 / 2.286852 = $241.25 per Year.

Premium Tyre Cost : $800

Life : 4 Years

Discount Rate : 10%

Annuity Factor @10% for 4 Years : 1/(1.10)^1 + 1/(1.10)^2 + 1/(1.10)^3 + 1/(1.10)^4 : 3.169865

Effective Annual Cost : Standard Tyre Cost / Annuity Factor

= $800 / 3.169865 = $252.38 per Year.

So Effective Annual Cost of Standard Tyres is Less than Effective Annual Cost of Premium Tyre. He should buy Standard Tyre.

Correct answer is Option A.

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