Question:
A taxi driver drives a taxi 50,000 miles a year. A new cab costs $12,000. He can drive the cab 200,000 miles with original engine and transmission. (It lasts longer than an ordinary car because he changes oil every 3,000 miles and because a taxi engine never gets cold, he explains.) Repair cost will average $0.04 a mile for the first 200,000 miles. After 200,000 miles, he can sell the car for $200 or spend $2,000 for a rebuilt engine and transmission. With a new engine and transmission, the cab will then last another 200,000 miles with additional repair costs averaging $0.08 a mile. The salvage value after 400,000 miles is approximately zero. His required return is 10%.
Should he get a new cab every 200,000 miles or every 400,000 miles assuming year-end cash flow for simplicity?