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DIA [1.3K]
3 years ago
15

A company is considering replacing its air conditioner. Management has narrowed the choices to alternatives that offer comparabl

e performance and considerable savings over their present system. The effective annual interest rate is 8%. What is the benefit-cost ratio of the better alternative?
Business
1 answer:
Naya [18.7K]3 years ago
4 0

Answer:

The benefit cost ratio of alternative 2 is 1.34

Explanation:

Initial cost $7000 $9000

Annual savings $1500 $1900

Salvage value $500 -$1250

Life 15 years 15 years

First, we calculate the present worth of Alternative 1 and 2, taking salvage value as a decrease in cost

.

For alternative 1

B1 = Benefits = ($1500)(P/A, 8%, 15) = ($1500)(8.5595) = $12,839

C1 = Cost = $7,000 – ($500)(P/F, 8%,15) = $7,000 – ($500)(0.3152) = $6842

Ratio of Benefit to Cost = Benefit/Cost = $12,839/$6842 = 1.88

For alternative 2

B2 = Benefits = ($1900)(P/A, 8%,15) = ($1900)(8.5595) = $16,263

C2 = Cost = $9000 + ($1250)(P/F,8%,15) = $9000 + ($1250)(0.3152) = $9394

Ratio of Benefit to Cost = Benefit/Cost = $16,263/$9394 = 1.73

Both alternatives can't be compared directly unless we perform incremental analysis on both.

Incremental Analysis =. (B2 – B1)/(C2 –C1) = ($16,263- $12,839)/ ($9394 - $6842) = 1.34

Incremental Analysis is greater than 1, so alternative 2 is better than alternative 1

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