Question
In: Economics
The M2 Corporations is considering expanding its ergonomics consulting business. To do so, several pieces of...
The M2 Corporations is considering expanding its ergonomics consulting business. To do so, several pieces of equipment for performing a given analysis technique must be purchased. The CEO estimates that it will cost $155,000 to expand the business, resulting in $32,000 in revenues per year, $12,000 in expenses per year, and a salvage value of $3,000. If the useful life of the expansion is expected to be 15 years, and the corporation's MARR is 15%...
a) Should they undertake the expansion? YOU MUST USE BENEFIT/COST RATIO
b) What would the break-even point be for annual revenues for this problem?
Solutions
Expert Solution
a) Pls see table below for calculations. We see that B/C ratio is less than 1, and hence this project should not be selected.
| Net CF / 1.15^Time | ||||||
| T | Investment | Revenue | Cost | Salvage Value | Net CF | PV @ 15% |
| 0 | -155000.00 | -155000.00 | -155000.00 | |||
| 1 | 32000.00 | -12000.00 | 20000.00 | 17391.30 | ||
| 2 | 32000.00 | -12000.00 | 20000.00 | 15122.87 | ||
| 3 | 32000.00 | -12000.00 | 20000.00 | 13150.32 | ||
| 4 | 32000.00 | -12000.00 | 20000.00 | 11435.06 | ||
| 5 | 32000.00 | -12000.00 | 20000.00 | 9943.53 | ||
| 6 | 32000.00 | -12000.00 | 20000.00 | 8646.55 | ||
| 7 | 32000.00 | -12000.00 | 20000.00 | 7518.74 | ||
| 8 | 32000.00 | -12000.00 | 20000.00 | 6538.04 | ||
| 9 | 32000.00 | -12000.00 | 20000.00 | 5685.25 | ||
| 10 | 32000.00 | -12000.00 | 20000.00 | 4943.69 | ||
| 11 | 32000.00 | -12000.00 | 20000.00 | 4298.86 | ||
| 12 | 32000.00 | -12000.00 | 20000.00 | 3738.14 | ||
| 13 | 32000.00 | -12000.00 | 20000.00 | 3250.56 | ||
| 14 | 32000.00 | -12000.00 | 20000.00 | 2826.57 | ||
| 15 | 32000.00 | -12000.00 | 3000.00 | 23000.00 | 2826.57 | |
| B/C Ratio | 0.76 | |||||
| (Sum of PV of Net CF T1toT15 / -Investment) |
b) We need revenues to be at least as much as would make the B/C ratio equal to 1.
The PV of Net CF (year 1 to year 15) is about 117K right now, and we need it to be 155K for B/C Ratio to be 1. Hence the yearly net CF which is about 20K per year will need to be 20K * 155K / 117K = 26.5K per year. This implies that revenue needs to be about 38.5K (since 26.5K is after deducting expenses of 12K, and we are assuming that expenses don't go up with an increase in revenue). Pls see calculations below for break even revenue.
| Net CF / 1.15^Time | ||||||
| T | Investment | Revenue | Cost | Salvage Value | Net CF | PV @ 15% |
| 0 | -155000.00 | -155000.00 | -155000.00 | |||
| 1 | 38500.00 | -12000.00 | 26500.00 | 23043.48 | ||
| 2 | 38500.00 | -12000.00 | 26500.00 | 20037.81 | ||
| 3 | 38500.00 | -12000.00 | 26500.00 | 17424.18 | ||
| 4 | 38500.00 | -12000.00 | 26500.00 | 15151.46 | ||
| 5 | 38500.00 | -12000.00 | 26500.00 | 13175.18 | ||
| 6 | 38500.00 | -12000.00 | 26500.00 | 11456.68 | ||
| 7 | 38500.00 | -12000.00 | 26500.00 | 9962.33 | ||
| 8 | 38500.00 | -12000.00 | 26500.00 | 8662.90 | ||
| 9 | 38500.00 | -12000.00 | 26500.00 | 7532.95 | ||
| 10 | 38500.00 | -12000.00 | 26500.00 | 6550.39 | ||
| 11 | 38500.00 | -12000.00 | 26500.00 | 5696.00 | ||
| 12 | 38500.00 | -12000.00 | 26500.00 | 4953.04 | ||
| 13 | 38500.00 | -12000.00 | 26500.00 | 4306.99 | ||
| 14 | 38500.00 | -12000.00 | 26500.00 | 3745.21 | ||
| 15 | 38500.00 | -12000.00 | 3000.00 | 29500.00 | 3625.39 | |
| B/C Ratio | 1.00 | |||||
| (Sum of PV of Net CF T1toT15 / -Investment) |
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