Question

5) (24 points) Norton, Inc has $800,000 to invest and is considering two projects with cash flows over a 10- year planning horizon estimated to be as follows: Project A Project B Initial Investment $800,000 $700,000 Annual Profit $135,000 $120,000 MARR is 10% per year compounded annually. The company can choose to invest in one of these projects or decide not to invest in either project. What is your recommendation for the company? Solve using the benefit-cost ratio analysis.

Answer 1

We can compare the two alternatives using incremental Benefit cost ratio.

$\large BCR = \frac{\triangle PW_{Benefits}}{\triangle PW_{Cost}}$

Here alternative A has a higher intial investment thus consider it as challenger and consider B as defender.

	A	B	∆(A-B)
Investment	800,000	700,000	100,000
Annual Benefit	135,000	120,000	15,000

Calculating the Present worth of benefit

∆PW(Benefit) = 15,000(P/A,10%,10) = 15,000 × 6.1445 =$ 92,168.51

$\large BCR = \frac{\triangle PW_{Benefits}}{\triangle PW_{Cost}}\\ \\ \implies BCR = \frac{92,168.51}{100,000} = 0.921$

The incremental Benefit Cost Ratio is less than 1. Hence, select project B.

The company should select Project B.