That older car of yours is starting to show signs of wear, and it seems month after month you’re fixing something or other.
When should you call it quits and upgrade to something newer?
If you’re frugal, you’re trying to get every last stinking mile out of your car possible. If you’re like me with 4 kids, you think it makes no sense to get something newer that kids will destroy. The body of my black 2000 Nissan Maxima (bought used with 50,000 miles in April of 2005) is in fairly good condition, the car looks decent, and I’ve taken care of it. I’ve got 145,000 miles on the car and in the last couple of years I’ve had to replace several costly parts, including new tires for about $300, the alternator cost about $600, the new radiator last month cost another $500, and the exhaust system replacement cost another $300. Not to mention, someone broke the lock last Thanksgiving breaking into my car (which cost $350 to fix). Throw in other small items and the bill in just 2 years was over $2000.
Nearly every time a new bill came up I wondered to myself if it was time to buy something newer.
As an Accountant who has worked for various large manufacturers with multiple plants and millions in equipment, I’ll share how we evaluate purchasing or replacing capital equipment and other big purchases. I’ll then help you better evaluate a potential large purchase or replacement purchase should your car breakdown, your roof starts leaking, your water heater starts giving you problems, or maybe your A/C is on the fritz and your unsure whether to pay for a service call or if you should go ahead and buy instead of taking a chance wasting money on a call.
Payback Period and Internal Rate of Return are so simple to understand, they really sound more complicated than they are.
Payback Period, like Internal Rate of Return (IRR) are simply cost-benefit tools. Businesses use them to determine how long it will take to recover costs, so they look at how much revenue the asset they are buying will produce and comparing that to how long it will take for them to payback the cost of the asset. In other words, they use various financial formulas to help determine which investment is best.
Take a piece of equipment like a new baking oven that costs $1,000,000 and it produces $500,000 in profit per year. The payback period would be 2 years, as it would take two years to recover the $1,000,000 in cost. Now say you can either buy the new baking oven, or a new building with more retail space for $1,000,000. The new building would generate $400,000 more in sales each year. The payback period would be 2.5 years. If you have to pick, you would choose to invest in the baking oven.
The Internal Rate of Return, net present value, discounted cash flow, and other formulas are used to take into account interest rates for financing the asset, as well as analyzing cash flows to better calculate the true return and payback periods on investments.
When deciding whether to buy a newer car or not you need to decide whether you’re spending more by maintaining your car or if you’re better off with a payment by analyzing the cash flows like you would do in using a formula like Payback Period, Net Present Value or Internal Rate of Return. If you’re able to hold off and save money to pay cash for a car you can avoid the interest charges you will pay the bank and instead earn interest on your deposits, thus saving you tons of money in the long run.
Let’s continue with the car example.
So, I spent $2,000 in two years on my car. If I were to have bought another newer used car and avoided all of the replacement costs, I would have spent about $15,000-$20,000 or around $400 per month. So in two years I would have spent $9,600 in payments. Not to mention, I would still owe $400 for 24 months or two years too. That’s an additional $7,600 to have less hassles with a car up to this point. And many know there is no guarantee with even newer vehicles, even those repairs may be covered by warranty – but you still have the hassle of getting the car repaired.
Obviously the question looms, how much longer will my car keep going and what could possibly wrong with the car before I would part with it. Let’s say a transmission went out on the car for $700, or even the motor for $2,500. It’s clear, I could have replaced all of these things and still been better off than buying newer in just two years. After four years I would have spent nearly $10,000 more to not have to potentially deal with a car breaking down.
Not to mention, a newer car means a higher insurance premium. With an older car I only carry liability insurance, with a newer car you will have to carry comprehensive. That would cause my car insurance to double.
Now what if we would have instead taken the money that we paid for the newer car and invested it in savings instead, over 2 years compounded annually at 4%, we would have ended up with nearly $8,100 and would have been half way to paying cash for a newer car. If you had bought and financed it, the bank would earn that off of you. Why give them the money?
When considering buying an entire new roof, new A/C, or water heater, ask yourself what will repairs cost compared to buying new.
If a service call costs $100 and buying new is only $500, and you know your A/C is past it’s warrantied use, you need to ask yourself if it makes sense to pay the $100 if this is the 2nd or 3rd time. Being frugal doesn’t necessarily mean being cheap either. It may cost you more in the long run to keep repairing, instead of buying new. See if they will apply service costs towards a new purchase if something is fatally broken or irreparable. If you can put it off, do it and build a cash stash instead. Only buy new as a last resort. Being frugal is being smart, if your car can be fixed for a reasonable price, fix it. Avoid pay financing charges and build cash to buy your next big purchase. Unless a car is breaking down so frequently that it’s affecting your ability to get to work, putting your job in jeopardy, deal with the issues as they arise and you will save a ton of money.