Tuesday, August 16, 2011

Vehicle Repair: Maintain vs Cut Your Losses

Maintaining a failing vehicle is a good analogy to stewardship in a corporate finance setting. Consider: in 2006 we bought a beautiful rebuilt (aka ‘salvaged’) 2004 Honda CRV with only 5,000 miles for $14k. At the time, the blue book value for a similar CRV not salvaged was close to $25k.
Considerations for taking this risk:
1) We desperately needed a car. And we strongly prefer to have a small SUV like a CRV, Rav4, etc…
2) We don’t have much money. A year earlier we had left the Peace Corps with hardly any financial assets.
3) We’re highly materialistic people so buying an old beat-up 1980s Mazda just wasn’t an option.
We saved ourselves over $10k and we had a beautiful car that we otherwise could never afford.

Here come the financial considerations. At what point would you, as a financial professional, “maintain the asset” or “cut your losses”?
1) 1 year after we bought the car, we finally check out the growling noise emanating from under the hood. Turns out it’s the transmission, and it needs to be replaced.
  • Cost = $2500.
  • Decision = Maintain the asset. I just bought this car. I’m ticked off. But since smashing the car with a baseball bat isn’t an option, I pay up.
2) 2 years after we bought the car. The transmission starts to growl again. Clearly the disreputable mechanic didn’t do a very good job of rebuilding the transmission.
  • Cost = Not sure but probably another $2500 since we don’t have a warranty
  • Decision = Do nothing. Let the transmission run into the ground.
3) 4 years after we bought the car, the radiator starts to leak on a barren highway between Bend and Portland. Scared and nervous, we manage to keep going with a $3 bottle of “bars leaks.” Upon returning to Tacoma, we get the car checked out. Indeed, we need a new radiator, pipes and thermostat.
  • Cost = $900.
  • Decision = Do nothing. I’d rather keep plugging up the leaking radiator with “bars leaks.”
4) 5 years after we bought the car, something stinky (literally “smelly”) is going on. Not only is the radiator still leaking, but the water pump is leaking, tubes are leaking and the thermostat thinks that everything is hunky dory. Prognosis: still need a new radiator, and also water pump, tubes, serpentine belt, and a couple of other belts.
  • Cost = $1500.
  • Decision = Maintain the asset. We had gotten over a year more of run time on the old radiator. And it isn’t uncommon for a vehicle with over 100k miles to need a new water pump. Pay up.
5) 2-5 years (at the same time) the transmission is growling louder, people start to tell us “wow you should get that looked at” (our response: “no, we know what it is already.”), it starts to sputter, and finally, in year 5, it starts to hum. The hum is loud, like a fog horn coming from under the passenger’s feet. Prognosis: the current transmission specialist says it best: “you got a crappy transmission. It needs to be replaced.
  • Cost = $2500
  • Decision = ? What would you do? $2500 would keep the car running for likely another 5 years, at which time it’s definitely time to get a new car. Keep in mind that other than a brake replacement and new tires, no other work has been done on the CRV. No tune up, no timing belt. It runs really well.
In the corporate finance setting, it would be asked, “has the asset been fully depreciated.” Answer = not really. It was paid through a low student loan interest rate, which we’re slowly paying off over the next 20 years. Next the finance person would say, “what are my alternatives”? The alternative, as we see it, is to invest in a new car for our new life stage: ie, a bigger SUV capable of hauling around 2 boys and their soccer gear. Cost = $40,000. Loan term = 5 years at 5% interest. Monthly payment = $700. Breakeven analysis: getting the transmission repaired will pay for itself after 4 months of new car payments.

In the corporate setting, they would likely continue to maintain the asset. But it still stings. The only true way to solve this dilemma is to make a time machine and decide not to buy the car in the first place. But even then… even then… even then… after all the repairs, we’re still cheaper than if we had bought a new CRV in 2006.

1 comment:

Cayla Maggio said...

I'm impressed with the thought that went on this one. It's like a check list that you provided. In fact, you can replace "car" with anything and just use the relevant price ranges to know if it's worth fixing up or not. It's too bad time machines don't exist, but using your suggestion, we'd know if we can stretch the value of a car, or anything, and of the money that we have. Thanks!

Cayla Maggio @ Nowthen Transmission & Auto Repair