Listed in Problem are some probability estimates of the costs and benefits associated with two competing projects.
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COST BENEFIT ANALYSIS |
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|
A |
B |
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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 |
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|
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 |
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|
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 |
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|
Annual tangible benefits starting with |
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 alternative. Round the cost projections to the nearest month. Explain what happens to the answer if the probabilities of the recurring costs are incorrect and a more accurate estimate is as follows:
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A |
B |
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|
.10 |
$ 75,000 |
.4 |
$ 85,000 |
|
.55 |
95,000 |
.4 |
100,000 |
|
.35 |
105,000 |
.2 |
110,000 |
b. Repeat step (a) for the payback method.
c. Which method do you think provides the best source of information? Why?