Question

Exercise 12-14 Identification of Relevant Costs [LO12-1]

Kristen Lu purchased a used automobile for $28,600 at the beginning of last year and incurred the following operating costs:

  

Depreciation ($28,600 ÷ 5 years)	$5,720
Insurance	$3,000
Garage rent	$1,500
Automobile tax and license	$780
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 $5,720. The car is kept in a garage for a monthly fee.

  

Required:

1.

Kristen drove the car 22,000 miles last year. Compute the average cost per mile of owning and operating the car. (Round your answers to 2 decimal places.)

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? (You may select more than one answer. Single click the box with a check mark for correct answers and double click to empty the box for the wrong answers.)

	Variable operating costs
	Depreciation
	Automobile tax
	License costs
	Insurance costs

Answer 1

1. Average cost per mile: $0.64

Total fixed cost of owning and operating the car = $5720 + $3000 + $1500 + $780 = $11000

Average cost per mile = ($11000/22000 miles) + $0.14 = $0.50 + $0.14 = $0.64

2. Variable operating costs

The only relevant costs are the variable operating costs. Depreciation, automobile tax, license costs and insurance costs are irrelevant because they will remain unchanged irrespective of whether Kristen uses her own car or rents a car.