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 $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 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. 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

a. The marginal (added) benefits of the proposed new robotics = $800,000

b. The marginal (added) cost of the proposed new robotics = $150,000

c. The net benefit of the proposed new robotics = $650,000

d. The company shall get the new robotics as there is net benefit of $650,000, and future benefits are more than current benefits.

e. Besides the costs and benefits the company shall consider the following factors also:

Time value of money,

Employees Training cost if required for new robotics.

Employees behavior towards this installation.

Environmental effects of such robotics, installed.

Step-by-step explanation:

Provided details as follows:

Benefits every year with new robotics = $560,000

Benefits every year with old robotics = $400,000

Cost of new robotics = $220,000

Resale price of old robotics = $70,000

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

Marginal benefits are additional benefits

Benefits every year with new robotics = $560,000 per year

Less: Benefits every year with old robotics = $400,000 per year

Thus Marginal (added) Benefits = $160,000 for 5 years = $800,000

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

Marginal added cost will be additional cost

Cost of new robotics = $220,000

Less: Resale price of old robotics = $70,000

Marginal added cost = $150,000

c. The net benefit of the proposed new robotics

The net benefit of the proposed new robotics = Marginal (added) Benefits $800,000 - Marginal added cost $150,000 = $650,000

d. The company shall get the new robotics as there is net benefit of $650,000, and future benefits are more than current benefits.

e. Besides the costs and benefits the company shall consider the following factors also:

Time value of money,

Employees Training cost if required for new robotics.

Employees behavior towards this installation.

Environmental effects of such robotics, installed.