Drexell Industries is a medium-sized diversified manufacturing company which operates subsidiaries in several different industries. Top management has established corporate goals which include a target return on shareholders' investment (before tax) of \(25 \%\). The performance of each subsidiary is evaluated using return on investment, and is considered satisfactory whenever ROI during a year is in excess of this amount. The manager of the Small Valve Division, Sally Hardsell, has been quite proud of her division's performance. During the most recent year this division had a ROI of \(30 \%\), and Sally is determined to maintain this above average record of profitability.

Sally is considering the purchase of a new piece of equipment, a computer-controlled multi-spindle lathe, which promises to increase productivity at a substantial savings in labor cost. The lathe has an original cost of \(\$ 300,000\) but will provide incremental benefits totaling \(\$ 96,000\) per year over its five year useful life. It will be obsolete at the end of that time and will have no salvage value.

{Required:}

(a) In evaluating this capital investment for the Small Valve Division, determine its

(1) return on investment (more properly known as the accounting rate of return);

(2) internal rate of return.

(b) Should the lathe be purchased? Explain the reason(s) for your answer.