A vehicle costs $14,000 when new and has a trade-in value of $6,600 at the end of four years. Its operating expense is $3,300 per year with an additional $1,000 for tires, tune up and battery at the end of the second year. All values are given in today's dollars. What is the equivalent annual cost of owning this vehicle for four years assuming a 10% market interest rate and expected inflation of 2%?

Equivalent annual cost of owning this vehicle for 4 years : Total economic cost/4 = (explicit cost + implicit cost)/4

The answer is 6,770 dollars.

Given :

Purchase of vehicle = $14,000

Resale value of car = $6,000 (at end of 4 years)

Operating expense = $3,000 per year

Tune up and battery cost = $1,000 at end of second year

Market interest rate = 10% (nominal interest rate)

Expected inflation rate = 2%

Real interest rate = nominal interest rate - inflation rate = 10% - 2% = 8%

Equivalent cost of owning this vehicle for 4 years :

Total economic cost = explicit cost + implicit cost = (fixed cost + variable cost ) + implicit cost

= (14,000 + 3,300*4 + 1,000*2) + 14,000*0.08*4 - 6600

= (14,000 + 13,200 + 2000) + 4,480 - 6600

= 27,080 dollars

Equivalent annual cost of owning this vehicle for 4 years : 27,080 dollars/4 = 6770 dollars