Draw a decision tree for this problem. To simplify it, look at the sit- uation on...

 

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Draw a decision tree for this problem. To simplify it, look at the sit- uation on a yearly basis for 3 years. If you buy the new car, you can anticipate cash outflows of 12 × $201.85 = $2,422.20 plus maintenance costs. For the used car, some of the repair costs are known (immediate repairs this year, tires next year), but we must model the uncertainty associated with the rest. In addition to the known repairs, assume that in each year there is a 20% chance that these uncertain repairs will be $500, a 20% chance they will be $2,500, and a 60% chance they will be $1,500. (Hint: You need three chance nodes: one for each year!) To even the comparison of the two cars, we must also consider their values after 3 years. If you buy the new car, it will be worth approxi- mately $8,000, and you will still owe $4,374. Thus, its net salvage value will be $3,626. On the other hand, you would own the used car free and clear (assuming you can keep up with the repair bills!), and it would be worth approximately $2,000. Include all of the probabilities and cash flows (outflows until the last branch, then an inflow to represent the car's salvage value) in your decision tree. Calculate the net values at the ends of the branches. Draw a decision tree for this problem. To simplify it, look at the sit- uation on a yearly basis for 3 years. If you buy the new car, you can anticipate cash outflows of 12 × $201.85 = $2,422.20 plus maintenance costs. For the used car, some of the repair costs are known (immediate repairs this year, tires next year), but we must model the uncertainty associated with the rest. In addition to the known repairs, assume that in each year there is a 20% chance that these uncertain repairs will be $500, a 20% chance they will be $2,500, and a 60% chance they will be $1,500. (Hint: You need three chance nodes: one for each year!) To even the comparison of the two cars, we must also consider their values after 3 years. If you buy the new car, it will be worth approxi- mately $8,000, and you will still owe $4,374. Thus, its net salvage value will be $3,626. On the other hand, you would own the used car free and clear (assuming you can keep up with the repair bills!), and it would be worth approximately $2,000. Include all of the probabilities and cash flows (outflows until the last branch, then an inflow to represent the car's salvage value) in your decision tree. Calculate the net values at the ends of the branches.

Answer rating: 100% (QA)

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