Ken Allen, capital budgeting analyst for Bally Gears, Inc., has been asked to ev
ID: 2725330 • 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 todays dollars) over that same time period. An initial cash investment of $220,000 would be required to install the new equipment. The manager estimates that the existing robotics can be sold for $70,000. Show how Ken will apply marginal cost benefit analysis techniques to determine the following:
A) The marginal (added) benefits of the proposed new robotics is?
B) The marginal (added) cost of the propsed new robotics is ?
C) The net benefit of the propsed new robotics is
D) What should Ken recommend that the company do? Why?
E) What factos besides the costs and benefits should be considered before the final decision is made?
Explanation / Answer
A./
MARGINAL ADDED BENIFITS
= BENEFITS FROM NEW ROBOTIC - BENEFITS FROM OLD ROBOTIC
= $560000 - $400000
= $160000
B./
MARGINAL ADDED COST
= INITIAL COST OF NEW ROBOTIC - SALVAGE VALUE OF OLD ROBOTIC NOW
= $220000 - $70000
= $150000
C./
NET BENEFIT
= $160000 - $150000
= $10000
D./
COMPANY SHOULD GO WITH REPLACING THE OLD ROBOTIC WITH THE NEW ONE, BECAUSE IT HAS A POSITIVE NET BENEFIT.
E./
BEFORE FINAL DECESSION THE COMPANY SHOULD CHECK THE IMPORTANT POINTS OF TIMMING, CASHFLOW, RISK FOR MAXIMISING THE WEALTH.
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