### Speaking of Bad Assumptions....

November 05, 2009
– Comments (17)

A recent blog post of mine drew some fire for leaning on data from Edmunds.com - critcism which stated that Edmunds' assumptions were simply unreasonable. You know what? Fair enough. I don't know enough about the industry to say one way or another and am certainly willing to admit that there's a possiblility that Edmunds' figures were off by good margin.

Apparently, however, there are more than enough bad assumptions to go around for everyone.

A couple of my recent blog posts which were critical of the Cash for Clunkers program have draw a little bit of fire from Fools who argue that the fuel savings alone justify the $3 Billion pricetag for the program.

Without picking on anyone in particular (as I've seen this kind of logic presented a couple of times), the argument goes something like this:

Average mpg differential between new car and clunker: 24.9 vs. 15.8

Average cost for a gallon of fuel: $2.50

Average lifespan of a car: 150K miles.

Cars traded-in during program: About 750K

Therefore one can calculate the fuel savings as follows:

Gallons used by a new car: 150K miles / 24.9 mpg = 6,024 gallons

Gallons used by a clunker: 150K miles / 15.8 mpg = 9,494 gallons

Difference in gallons: 9,494 - 6,024 = 3,470

Dollars of fuel saved = 3,470 gallons / car x 750k cars x $2.50 / gallon = $6.5 Billion

Well worth the $3 Billion pricetag, no?

Um... well... no. Not by a longshot!

There are two problems with the above approach I can think of right off the bat, one far worse than the other one, but let's address the lesser problem first.

First, the $3 Billon was spent today whereas the $6.5 Billion would be saved over the lifetime of the vehicles. One would need to discount the $6.5 Billion spent over time at some discount rate to get the equivalent in today's dollars in order to have a valid comparison.

But that's not the real problem.

The real problem is the 150K miles assumption. The above math assumes that not only would the new car be driven for 150K miles, so would the clunker! That, I believe, is an assumption far worse than any made by our friends at Edmunds.

In fact, *the U.S. Department of Transportation reports that the average life span of a vehicle is just over 13 years, with a final mileage of 145,000 miles.* (link)

Furthermore, according to Hyundai, *The average age of a trade-in model was nearly 14 years old; the average odometer reading was more than 140,000 miles.* (link)

So, if we assume Hyundai's experience was similar to the industry as a whole, the average remaining lifespan for a clunker traded in wasn't 150K miles, but only 5K miles.

Using the same calculation as above but instead using 5K miles as the amount of miles over which the fuel savings are realized leads to a savings not of $6.5 Billion, but of only $217 Million.

Now, one, I suppose, could argue with some of the assumptions presented here too. Fair enough. Feel free to substitute your own if you wish. In no case, however, is the fuel savings in the billions of dollars nor does it even remotely come close to approaching the amount of money spent on the program.

It just simply doesn't add-up.

Regards,

Russell (a.k.a. TMFEldrehad)