Question 10.P.1: Mr. Jones bought a new car in September 1981 for $7800. He p......
Mr. Jones bought a new car in September 1981 for $7800. He paid $2400 down, and financed the balance with a loan at 18% nominal interest to be repaid in 35 monthly installments of $199.42 each. It is understood that if Mr. Jones fails to make a payment, the car will be repossessed by the loan company and, though Mr. Jones will owe nothing, he will lose all money already paid. He can also pay the outstanding balance of the loan at any time. Twelve months after the transaction, Mr. Jones’s balance is $3855. Thanks to a good deal, Mr. Jones has this amount and is going to pay off the loan. At this point, Mr. Jones’s brother offers him an essentially identical car (they bought the same model the same day, and the use and maintenance of both cars have been very similar) for $3500. Mrs. Jones would prefer to keep their current car “because we have already spent almost $4800 on it.” What is the sensible decision to make?
This is a clear and very common instance of a sunk cost: Mrs. Jones is wrong in her analysis. While it is true that they have invested a large amount of money so far, it is also true that this money will not be recovered, no matter what decision is taken. The sole question is whether Mr. Jones should acquire a car for $3855 or acquire a car for $3500. Provided the two cars are physically equivalent, the answer is obvious.