Cash for clunkers: A real lemon

If the government's Cash for Clunkers program has you thinking about buying a new car, think again. Buying a brand new car is one of the worst investments a person can make and Cash for Clunkers does not change the economics. Here is an example that illustrates what I mean.

Let's suppose I have a 1995 Chevy Tahoe that needs to be replaced. According to Edmunds, my Tahoe gets about 12 miles per gallon and is worth about $1,500. If I trade it for a new 2009 Toyota Camry (MSRP $25,000), I will qualify for the maximum credit of $4,500 under the Cash for Clunkers program. On the surface, that looks like a pretty good deal which is why some dealer showrooms have been flooded with frenzied car buyers.

But dig a little deeper and the deal begins to look less attractive. For example, that brand new 2009 Camry is probably going to drop in value by 20% in the first year. That means you will loose $5,000 as soon as you drive it home. The net cost of buying the new Camry is $25,000 less the $4,500 Cash for Clunkers credit plus the $5,000 first year depreciation or $25,500.

Now let's compare the Cash for Clunkers deal with what I would pay by trading my Tahoe for a one-year old Toyota Camry. The used Camry will cost me about $20,000. Subtracting the $1,500 trade-in value of my Tahoe means my net cost is $18,500. Throw in the first year depreciation on the used Camry (20% of my purchase price) of $4,000 and my total cost of buying the used car is $22,500. Buying the used Camry still puts me ahead by $3,000.

Obama once quipped, "You can put lipstick on a pig, but its still a pig!" The same applies to Cash for Clunkers.