120 marks Acme Corporation is planning to open a new divisio

120 marks) Acme Corporation is planning to open a new division for biotherapeutic drugs. The company expects to pay $100 million for set up costs. Annual be $5 million for the operating expenses are expected to next 12 years. The company estimates that it will be able to generate annual revenue of $50 million beginning 5 years from now. What is the conventional B-C ratio, using AW, for this investment if MARRìs15%per year and the project life is 12 years?

Solution

Computation of Conventional Benefit Cost Ratio using Annual Worth (AW)

Initial Set up Cost $100 million

Annual operating Expenses (for next 12 years) $5 million

Annual Revenue (beginning from 5th year) $50 million

Minimum Acceptable Rate of Return (MARR) 15%

Project Life in years 12 years

Annual Worth of Benefits - Annual Worth of Disbenefits

Conventional Benefit Cost Ratio = -----------------------------------------------------------------------------

Initial cost + Operating Cost - Salvage Value

(Amount in $ Million)

Year

0

1

2

3

4

5

6

7

8

9

10

11

12

Benefits

0

0

0

0

0

0

$50

$50

$50

$50

$50

$50

$50

PVF 15%, 12 yrs

0

0.870

0.756

0.658

0.572

0.497

0.432

0.376

0.327

0.284

0.247

0.215

0.187

PVB

0

0

0

0

0

0

21.6

18.8

16.35

14.2

12.35

10.75

9.35

Cost

$500

$5

$5

$5

$5

$5

$5

$5

$5

$5

$5

$5

$5

B-C

-$500

-$5

-$5

-$5

-$5

-$5

$45

$45

$45

$45

$45

$45

$45

Conventional B-C Ratio = Total of AW Benefits / Total of AW Costs

= 21.6+18.8+16.35+14.2+12.35+10.75+9.35 500+4.5+3.78+3.29+2.86+2.16+1.88+1.64+1.42+1.24+1.08+0.94

=103.4 / 524.79

Conventional B-C ratio =0.197

Result = Reject the Project since B-C Ratio is less than 1

Year	0	1	2	3	4	5	6	7	8	9	10	11	12
Benefits	0	0	0	0	0	0	$50	$50	$50	$50	$50	$50	$50
PVF 15%, 12 yrs	0	0.870	0.756	0.658	0.572	0.497	0.432	0.376	0.327	0.284	0.247	0.215	0.187
PVB	0	0	0	0	0	0	21.6	18.8	16.35	14.2	12.35	10.75	9.35
Cost	$500	$5	$5	$5	$5	$5	$5	$5	$5	$5	$5	$5	$5
B-C	-$500	-$5	-$5	-$5	-$5	-$5	$45	$45	$45	$45	$45	$45	$45
PVC	$500	$4.35	$3.78	$3.29	$2.86	$2.49	$2.16	$1.88	$1.64	$1.42	$1.24	$1.08	$.94