The local electric company may renovate a number of substations within its system. Various costs and savings can be anticipated, depending on the type of renovation performed. Using benefit/cost analysis and an interest rate of 12%, determine which alternative should be chosen. Annual Annual Alternative First Cost Cost Savings Life A $1,100,000 $24,000 $180,000 20 years B 1,500,000 36,000 245,000 20 years C 1,750,000 41,000 295,000 20 years

Select Alternative C with benefit to cost ratio of 1.071

Explanation:

The cost benefit analysis is a method to compare several projects and decide which one is most feasible.

We have three alternatives here and will compare them and decide which one to select.

Alternative |    First Cost    |   Annual Cost  |   Annual Savings  |   Life

A                 |   1,100,000    |      24,000       |      180,000           |    20

B                 |   1,500,000    |     36,000       |      245,000          |    20

C                 |   1,750,000    |     41,000        |      295,000          |    20

Alternative A:

Total costs = First Cost + Total Annual Cost

Total costs = 1,100,000 + 24,000(P/A,12%,20)

Total costs = 1,100,000 + 24,000(7.469)

Total costs = 1,279,256

Total benefits = 180,000(P/A,12%,20) = 180,000(7.469) = 1,344,420

Benefit Cost Ratio = Total benefits/Total costs

Benefit Cost Ratio = 1,344,420/1,279,256

Benefit Cost Ratio = 1.051

Alternative B:

Total costs = First Cost + Total Annual Cost

Total costs = 1,500,000 + 36,000(P/A,12%,20)

Total costs = 1,500,000 + 36,000(7.469)

Total costs = 1,768,884

Total benefits = 245,000(P/A,12%,20) = 245,000(7.469) = 1,829,905

Benefit Cost Ratio = Total benefits/Total costs

Benefit Cost Ratio = 1,829,905/1,768,884

Benefit Cost Ratio = 1.034

Alternative C:

Total costs = First Cost + Total Annual Cost

Total costs = 1,750,000  + 41,000(P/A,12%,20)

Total costs = 1,750,000  + 41,000(7.469)

Total costs = 2,056,229

Total benefits = 295,000(P/A,12%,20) = 295,000(7.469) = 2,203,355

Benefit Cost Ratio = Total benefits/Total costs

Benefit Cost Ratio = 2,203,355/2,056,229

Benefit Cost Ratio = 1.071

Conclusion:

Select Alternative C because it has the highest benefit to cost ratio.

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