Question

QUESTION 7 10 point Calculate the incremental benefit-cost ratio based on the alternatives below. You need to account for the time value of money using an interest rate of 5% (Hintmake use of slide 8 in powerpoint presentation titled 'ECON-401-CH-08-09-10'). Year Alt A Alt B -$15,000 $7,500 $7,500 $7,500 -$10,000 $5,000 $5,000 S6.500

Answer 1

Answer 7)

Incremental benefit cost analysis

Alt A - Alt B

Year	Alt A	Alt B	Alt A - Alt B
0	-$ 15000	- $ 10000	- $ 5000
1	$ 7500	$ 5000	$ 2500
2	$ 7500	$ 5000	$ 2500
3	$ 7500	$ 6500	$ 1000

Given the interest rate ie. discount rate = 5%

Alt A - Alt B = - $ 5000 + $ 2500 / 1.05 + $ 2500 / 1.05² + $ 1000 / 1.05³
= - $ 5000 + $ 2380.95 + $ 2267.57 + $ 864.30
= - $ 5000 + $ 5512.82
= $ 512.82

Benefit / Cost ( B/C) = $ 5512.82 / $ 5000 = 1.1025 > 1

In incremental cost analysis we should take higher first cost alternative minus lower first cost. therefore as $ 15000 > $ 10000 we should subtract Alt A minus Alt B.

In incremental analysis if B / C > 1 one should choose higher first cost analysis and if B / C < 1, the lower first cost analysis should be chosen
Therefore Alt A should be chosen in the B / C analysis.