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
