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Chapter 8 Incremental Analysis (50 Points Problem 3 An oilcompany plans to purchase a large piee of vacant land for $77,500. There are four possible improvements over and above the cost of the land: Cost of s 75,000 Cost of $ 230,000 Cost of S 35,000 Cost of $ 135,000 Conventional service station Automatic car wash with pumps Discount self-service only Service station with quick car wash A. B. C. D. In cach case the estimated useful life is 15 years, and salvage value is the cost of the land. The net annual income, after paying all operating expenses is projected at: A. $22,500 B. $44,600 C. $16,500 D. $28,500 If the company requires a 9% rate of return, what should they do? Numerical Solution: PW Cost EUAB Salvage Computations: Use back of facing page or last page in this exam booklet, if necessary) Perform Incremental Analysis to select the best alternative Rearranged Alternatives: PW Benefit+ PW Salvage PW Cost Net Present Worth Decision Pairwise Comparisons Delta Altermative: A PW Benefit A PW Cost Decision 400,000 350,000 300,000 250,000 200,000 150,000 100,000 50,000 0 PW Cost

Answer 1

	A	B	C	D
PW Cost	152,500	307,500	112,500	212,500
EUAB	22,500	44,600	16,500	28,500
Salvage	77,500	77,500	77,500	77,500
PW Benefits	181,365	359,507	133,001	229,730	PV(0.09, 15,EUAB)
PW Salvage	21,277	21,277	21,277	21,277	PV(0.09, 15, , Salvage)
PW Benefits + PW Salvage	202,642	380,783	154,278	251,006
(PW Benefits + PW Salvage) - PW Cost	50,142	73,283	41,778	38,506

Since project B has the highest value of (PW Benefits + PW Salvage) - PW Cost, it should be chosen

	C	A	D	B
PW Benefits + PW Salvage	154,278	202,642	251,006	380,783
PW Cost	112,500	152,500	212,500	307,500
Net Present worth	41,778	50,142	38,506	73,283

With increase in costs, NPV shall increase, therefore A will be preferred over C, A over D and B over A. Finally, B will be selected.

Delta	A-C	D-A	B-A
delta PW Benefits	48,364	48,364	129,777
delta PW Cost	40,000	60,000	95,000
Decision	1.20910326	0.8060688	1.3660746
	as ratio >1, A selected	as ratio <1, A selected	as ratio >1, B selected