Ken Allen, capital budgeting analyst for Bally Gears Inc., has been asked to eva

ID: 2652664 • Letter: K

Question

Ken Allen, capital budgeting analyst for Bally Gears Inc., has been asked to evaluate a proposal. The manager of the automotive division believes that replacing the robotics used on the heavy truck gear-line will produce total benefits of 560,000 (in today’s dollars) over the next 5 years. The existing robotics would produce benefits of $400,000 (also in today’s dollars) over that same period. An initial cash investment of $220,000 would be required to install the new equipment. The manager estimates that the robotics can be sold for $70,000. Show how Ken would apply marginal cost-benefit analysis techniques to the determine the following:

The marginal (ADDED) benefits of the new proposed robotics.

The marginal (ADDED) cost of the new proposed robotics.

The net benefit of the new proposed robotics.

What should Ken recommend the company do? Why?

What factors besides the costs and benefits should be considered before the final decision is made?

Explanation / Answer

Marginal means additional. Marginal cost benefit analysis is used to evaluating the project. Instead of considering total cost and total benefit like conventional system in this approach only marginal cost and benefit analysed.

It means if a project is provide net marginal benefit then it may be an acceptable project.

Calculation of Marginal cost, Marginal benefit and net benefit.

Particulars

Amount

Present Value of Existing Benefit (a)

400,000

Present Value of Proposed benefit (b)

560,000

Marginal Benefit ( if robotics replaced) (b-a)

160,000

Existing Cost ( c)

Marginal cost if project accepted (d )

220,000

Marginal Cost (d-c)

220,000

Cash Flow from ale of existing robotics

70,000

Net Benefit

( Marginal benefit – Marginal cost + opportunity cost through sale of existing robotics)

10,000

(160,000+70,000-220,000)

Answer

Marginal Benefit-$ 160,000

Marginal Cost- $ 220,000

Net benefit - $ 10,000

Conclusion- As replacement showing net positive figure hence new robotics should be installed after sale of existing robotics.

Additional Factors

Beside analysis of financial data non-financial factors also play a crucial role for decision making in new projects. Significant social and environmental impacts need to be evaluated for decision making.

For evaluation of social impact following issues need to be considered.

Law and order

Workplace safety

For evaluation of environmental impact following issues need to be considered.

Environmental Impact Analysis need to be completed.