Question: Norwich Tool, a large machine shop, is considering replacing one of its lathes with either of two new latheslong dash-lathe A or lathe B. Lathe A is a highly automated, computer-controlled lathe; lathe B is a less expensive lathe that uses standard technology. To analyze these alternatives, Mario Jackson, a financial analyst, prepared estimates of the initial investment and incremental (relevant) cash inflows associated with each lathe. These are shown in the following table.
Lathe A Lathe B
Initial Investment $660,000 $360,000
Year (t) Cash Inflows Cash Inflows
1 $128,000 $88,000
2 182,000 120,00
3 166,000 96,000
4 168,000 86,000
5 450,000 207,000
a. Use the payback period to assess the acceptability and relative ranking of each lathe.
b. Assuming equal risk, use the following sophisticated capital budgeting techniques to assess the acceptability and relative ranking of each lathe:
(1) Net present value (NPV).
(2) Internal rate of return (IRR).
c. Summarize the preferences indicated by the techniques used in parts (a ) and (b ). Do the projects have conflicting rankings?
d. Draw the net present value profiles for both projects on the same set of axes, and discuss any conflict in rankings that may exist between NPV and IRR. Explain any observed conflict in terms of the relative differences in the magnitude and timing of each project's cash flows.
e. Use your findings in parts a through d to indicate, on both (1) a theoretical basis and (2) a practical basis, which lathe would be preferred. Explain any difference in recommendations.