Problem 7 Cost Benefit Analysis NEW INFORMATION< SEE BELOW; Textbook has wrong information.

Listed in the diagram for Problem 7 are some proability estimates of the costs and benefits associated with two competing projects.

Cost of Capital = .14

A B

Probability Amount Probability Amount

Project completion time 0.5 12 months 0.6 12 months

0.3 18 months 0.2 18 months

0.2 24 months 0.1 24 months

Expected useful life 0.6 4 years 0.5 4 years

0.25 5 years 0.3 5 years

0.15 6 years 0.2 6 years

one time costs 0.35 $200,000 0.2 $ 210,000

0.4 $250,000 0.55 $250,000

0.25 $300,000 0.25 $260,000

Recurring Costs 0.1 $75,000 0.4 $85,000

0.55 $95,000 0.4 $100,000

0.35 $105,000 0.2 $110,000

Annual tangible benefits starting

with weighted average completion

date. 0.3 $220,000 0.25 $215,000

0.5 $233,000 0.5 $225,000

0.2 $240,000 0.25 $235,000

A- Compute the net present value of each alter native. Round off the cost projections to the nearest month. Explain what happens to the answer if the proabilities of the recurring costs are in correct, and a more accurate estimate is as follows:

Company A Company B

0.10 $75,000 0.6 $85,000 in text is wrong, should be 0.6 not 0.4

0.55 $ 95,000 0.2 $100,000 in text is wrong, should be 0.2 not 0.4

0.35 $105,000 0.2 $110,000 this is right in the text

For 7a, all cash flows occur at year end of their respective period.

For 7b, all cash flows occur evenly distributed throughout the year.

Use weighted averages to calculate expected value of each category.

B-Repeat step a for the payback method.

C- Which method do you think provides the best source of information? Why?

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