Question

A 10 years restaurant project of social enterprise is planning to employ those yet-still-active retirees. Assume the interest rate is 10% per annum.

It costs:

• Setup of a restaurant = $750,000
• Salvage value = $200,000
• Annual Rent, and Operating Costs = $1,000,000
• Annual Salary = $10,000 ´ 8 staff = $80,000

It may achieve benefits:

• Annual Sales of meals = $1,000,000
• Annual Joy of Contribution = 30,000 x 8 staff = $240,000

Should the project be implemented? Justify your answer in terms of modified B-C ratio of AW. (Round off your answer to 3 decimal places.)

Answer 1

Time horizon = 10 years

Interest Rate = 10%

The costs include

Setup of a restaurant or initial cost = $750,000

Salvage value at year 10= $200,000

Annual Rent & Operating Costs = $1,000,000

Annual Salary = $10,000 per staff and for 8 staff = $80,000

The benefits are

Annual Sales of meals (Annual revenues) = $1,000,000

Annual Joy of Contribution = 30,000 x 8 staff = $240,000 per year

From the above we need to calculate the modified B/C Ratio.

Modified B/C Ratio on the basis of annual worth method

B/C Ratio = (Annual Benefits – Annual Costs) ÷ (Annual initial investment – Annual Salvage)

OR

B/C Ratio = (Annual Benefits – Annual Costs) ÷ Capital Recovery Cost

Total Annual Benefits = 1,000,000 + 240,000 = 1,240,000

Total Annual Costs = 1,000,000 + 80,000 = 1,080,000

Capital Recovery Cost = 750,000 (A/P, 10%, 10) – 200,000 (A/F, 10%, 10)

Capital Recovery Cost = 750,000 (0.16275) – 200,000 (0.06275) = 109,512.5

B/C Ratio = (Annual Benefits – Annual Costs) ÷ Capital Recovery Cost

B/C Ratio = (1,240,000 – 1,080,000) ÷ 109,512.5

B/C Ratio = 160,000 ÷ 109,512.5

B/C Ratio = 1.461