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 next5 years. The existing robotics would produce benefits of $400,000 (also in today's dollars) over that same 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 benefits of the proposed new robotics. b. The marginal costs 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 P1-4 decision is made?

Answer 1

Answer a:

Marginal benefits of the proposed new robotics = Total benefits (in today's dollars) with new robotics over 5 years - Total benefits (in today's dollars) with existing robotics over the same period

= $560,000 - $400,000

= $160,000

Marginal benefits of the proposed new robotics = $160,000

Answer b:

Marginal cost of proposed new robotics = Initial cash investment required to purchase and install new robotics - estimated sale value of existing robotics

= $220,000 - $70,000

= $150,000

Marginal cost of proposed new robotics = $150,000

Answer c:

Net benefit of proposed new robotics = Marginal benefit - Marginal cost = $160,000 - $150,000 = $10,000

Net benefit of proposed new robotics = $10,000

Answer d:

Ken should recommend replacing the existing robotics with new robotics.

As the replacement decision results in net marginal benefit of $10,000, Ken should recommend to replacement.

Answer e:

Other factors that should be considered besides cost and benefits before final decision is made:

1. If net savings (benefits) relates to saving in salaries/wages by terminating employment, effect of such terminations, regulatory requirements

2. Effect on quality of product

3. Effect on environment

4. Impact due to Compliance requirements, if any