Question

Marginal​ cost-benefit analysis and the goal of the firm   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 568,000​(in today's​ dollars) over the next 5 years. The existing robotics would produce benefits of 446,000 (also in​ today's dollars) over that same time period. An initial cash investment of $227,200 would be required to install the new equipment. The manager estimates that the existing robotics can be sold for $73,000. Show how Ken will apply marginal​ cost-benefit analysis techniques to determine the​ following:
a.  The marginal​ (added) benefits of the proposed new robotics.

b.  The marginal​ (added) cost of the proposed new robotics.

c.  The net benefit of the proposed new robotics.  

d.  What should Ken recommend that the company​do? Why?

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

Answer 1

Answer:

a.The marginal (added) benefits of the proposed new robotics.

• $195,000

b. The marginal (added) cost of the proposed new robotics.

• -$227,200

c. The net benefit of the proposed new robotics.

• loss =  -$32,200

d. What should Ken recommend that the company do? Why?

• Based only on this analysis, the company should keep the old robotics. The new robotics are too expensive and do not generate enough benefits.

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

• increases in efficiency and reductions in manufacturing time.

Explanation:

Marginal cost benefit analysis refers to analyzing the additional benefits of a new project or activity compared to the benefits generated by an alternative project or activity.

In this case, both alternative should be evaluated as follows:

                                alternative 1           alternative 2        marginal

                                keep robotics        change robotics  benefits

revenue (in              $446,000              $568,000             $122,000

today's $)  

required invest.                   $0             -$227,200           -$227,200

old robotics                         $0                $73,000               $73,000

sales value                                                                                          

marginal benefits / losses                                                  -$32,200