Gas prices continue to soar, your SUV gets 16 mpg, and your paycheck isn’t increasing.  Consumers feeling their pockets getting empty are starting to ask questions.  Could the high gas prices just be temporary? If not, then I guess it’s time to trade the SUV in and get a fuel efficient vehicle, right?  Actually that might not be the smartest idea.  In order to answer these questions we need to understand the current SUV situation and determine what this means financially.     

            Sport Utility Vehicles (SUV’s) have become the norm for a vehicle purchase over the last 10-15 years.  As many cars became smaller over this timeframe compared to the cars in the 1970’s, people became interested in sport utility vehicles and why wouldn’t they?  These vehicles have plenty of leg room, a large storage area, four-wheel drive, feel very safe due to their size, and are powerful.  One of the biggest selling features is they provide a higher seating position allowing the driver to view more of the road and surroundings. 

Not only did consumers have a desire for SUV’s, but they wanted larger SUV’s.  The big three U.S. vehicle manufacturers, Chrysler, Ford, and GM, were making extremely large profits on these vehicles.  The Ford Excursion, Chevy Suburban, Hummer, GMC Yukon, and Chevy Tahoe are the largest SUV’s on the market.  These vehicles were being bought by families, shuttle drivers, and small business owners.  Due to a tax break many small business owners and mostly anyone who could write off the vehicle as a work related expense became consumers for these enormous vehicles.  They were able to write off almost the entire cost.  This encouraged lawyers, doctors, accountants, and real estate agents to buy these SUV’s, when they really have no use for this type of vehicle.

            The U.S. vehicle manufacturers and consumers were both happy until the one major flaw of SUV’s was magnified.  These vehicles were gas hogs.  Hurricane Katrina started to reveal this flaw in 2005 when this hurricane caused disruption to refineries.  Gas prices soared above $3 a gallon.  Prices would start to come down as the refineries got back into full production, but not down to where they were before the hurricane.  This was due to the price of a barrel of crude oil rising to over $50.  In 2004 the average price of a barrel of crude oil was $37.  This brings us to July 4th, 2008 as the price of a barrel of crude oil is now over $145 and the price of a gallon of gas is over $4. 

            This has caused U.S. vehicles manufacturers to slow down and terminate some SUV lines which have been their most profitable over the last decade.  Consumers are now buying small fuel efficient cars and hybrid vehicles.  The problem for many consumers is they are looking to trade in or sell their SUV’s to purchase a fuel efficient vehicle, but there are not many takers for at least what the consumer feels is fair value.  Typical supply and demand has caused very fuel efficient cars and hybrid vehicles to sell for the ticket price or above.  SUV’s are selling way below ticket price since there are a lot more sellers than buyers.  Vehicle manufacturers are overloaded with SUV’s and the dealerships can’t sell the ones they already have on the lot.            

            Just this data makes it seem foolish to trade or sell a SUV at this time, but the financial numbers is what will really influence the decision.  There are many different situations a consumer might be in.  A consumer who is not able to afford fueling their SUV might need to trade their SUV in.  Perhaps there is no loan against it and the value of the SUV is high enough to get them an equally or lower priced car.  This means they directly cut down their gas expense and haven’t changed their monthly budget. 

            Some examples using numbers can probably give everyone a general idea to help with their decision making.  $30,000 is close to an average cost of a SUV.  To set-up this example we will say John purchased a $30,000 SUV four years ago.  With zero down and a 6% interest rate his payments are $580 a month and he has a current loan balance of $6000.  Let’s also examine Joan who purchased the same year and model SUV for the same amount but her loan is paid off.  Currently, a dealership is offering $9,000 for the SUV.  Therefore each consumer has sunk costs of $21,000.  Also this means John will have to use $6000 of the $9,000 trade in to pay his existing loan.  His balance of $3000 will go towards his new purchase and all of Joan’s $9,000 will be put towards her new purchase.  We will take a look at these situations in two different ways.    

            First we will look at the situations by monthly budget.  Since car payments are monthly payments we need to determine how much money is spent on gas each month.  We will use the current average U.S. gasoline price of $4 a gallon.  Joan’s roundtrip to her full-time job each day is 30 miles.  On the weekend she drives on an average 100 miles.  Therefore, Joan drives 1,000 miles a month.  At 16 miles per gallon she pays $250 a month.  Currently she doesn’t have a monthly car payment so her monthly total for gas and car payment is $250 a month.  Joan is looking to purchase a car which is the same model year as her SUV.  The car costs $15,000, but gets 27 miles per gallon.  After her $9000 SUV trade-in her monthly car payment will be $116 (using 6% interest rate).  Her monthly gas expense will be $150.  This equates to $266 a month for gas and car payment.  Her monthly expense for a car payment and gas is actually higher now which is mainly due to her only getting $9,000 for her SUV. 

John’s roundtrip to his full-time job each day is 60 miles.  On the weekend he drives 100 miles.  Therefore, John drives 1,600 miles a month.  John pays $400 a month in gas.  If John purchases this same car, then his monthly gas expense is $237.  After the $3000 John will be able to put towards his purchase, his car payment is $232.  His total expense for gas and car payment will now be $469.  John will actually save over $100 a month.  However he was in the last year of his SUV payments and now his car payments will continue for five years.   

            The second way we will look at these situations is to determine the break even point.  We can determine how many miles it will take in order to make up for the loss on the SUV.  The loss on the SUV is not the $21,000 sunk cost, but the difference in trade-in value from the time before gas prices skyrocketed to the present time.  The sunk cost has to do with trading in a vehicle for another one.  We won’t use the $21,000 since we are strictly looking at if the SUV is worth trading in just to get better fuel efficiency.  Before there was a large increase in gas prices, a typical SUV like John’s and Joan’s would have a trade-in value around $14,000.  Now the trade-in value is $9,000 which equates to a $5,000 difference.  In using cost accounting we need to determine the sale per mile and the variable cost per mile.  The $4 per gallon gas price needs to be converted to a cost per mile since we need to get the break even point in miles.  The sale per mile is just the SUV’s fuel cost per mile.  This is $4 a gallon divided by 16 miles per gallon which equates to a cost of 25 cents a mile.  The variable cost per mile is the car’s fuel cost per mile.  This is $4 a gallon divided by 27 miles per gallon which equates to a cost of 15 cents a mile.  Next we determine our contribution margin per mile which is the sale per mile of 25 cents minus the variable cost per mile of 15 cents which results in a 10 cents per mile contribution margin.  Finally we use the $5,000 loss and divide by the contribution margin per mile of 10 cents which provides the answer of 50,000 miles.  The break even point of 50,000 miles is the amount of miles that need to be driven in the car to recover the $5,000 loss on the SUV.   To simplify the problem we simply converting both vehicles’ cost of gas per mile and took the difference.  Then we divided the loss on the SUV by this difference.  It will take Joan over 4 years of driving the car to recover the SUV loss at her current usage and it will take John over 2.5 years. 

          The future of the gas prices is unknown which makes the future value of the SUV unknown also.  However, we know the value of an SUV has dropped significantly.  If we could have predicted this drop, then trading in the SUV before this occurrence would have avoided the $5,000 decline in value.  The problem is most SUV owners couldn’t make this prediction so they are presented with the situations we have examined.  In these examples we only looked at the financial numbers which alone didn’t strongly favor trading the SUV in for a car.  Also, like in the stock market, it doesn’t make sense to sell low and buy high which is currently happening when SUV’s are traded in for fuel efficient cars.  When we consider the advantages of a SUV which have led them to their popularity over the years it doesn’t make much sense to give these advantages up.  Perhaps the next time a consumer is ready to buy a new vehicle they won’t purchase a gas guzzling SUV, but for current SUV owners it makes sense to continue to enjoy the great features of these vehicles.