Emailer has money to pay cash for car, but should he?

In a perfect world, we'd pay cash for our car purchases. Not having a car payment is one of the best things ever. But what should you do if the car payment is going to drain your savings? I recently received the following question from an emailer, and I answered it on The Pete the Planner Radio Show.

Dear Pete,

I have a quick question for you I think you might be able to provide some insight on. I recently graduated from college and I've started my first real job. I've been fortunate in being able to work from home for the first couple months but soon I will need to move to the home office which is in another state. I have been borrowing a family car when I needed it living at home. I've tried to be pretty frugal through college and I have about $10,000 saved up through my time at this job and from working through college. I will need to buy a car within the next few weeks and I am strongly opposed to financing one. Do you think it would be a better idea to buy an older car for $3-4000 and maintain my cash which I've been working on building as an emergency fund? Or should I buy a newer car for $8-9000 that might last me longer but if I ran into trouble I wouldn't have much to fall back on? My medium term transportation plan is to spend the next 4 or 5 years paying myself a car payment so that I can buy the next car albeit a nicer one in cash as well so whatever I purchase needs to be reliable for at least that long. Extra information: I have no student loans and I make a livable but not excessive recent graduate salary. I will pay around 350$ a month for rent with a room mate. Also probably add 100$ a month for food. Other than that expenses shouldn't increase too much. After taxes withheld, insurance, 401k contributions, savings, rent, food and gas I expect to have around 500$ leftover from each month's check.

Larry

Good question, Larry. Here's my answer.