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Question 2: Cost benefit analysis 20 marks Norwich Tool, a large machine shop, is considering replacing one of its lathes with either of two new
Question 2: Cost benefit analysis 20 marks Norwich Tool, a large machine shop, is considering replacing one of its lathes with either of two new lathes - 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 analyse 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. Note that Mario plans to analyse both lathes over a 5-year period. At the end of that time, the lathes would be sold, thus accounting for the large fifth year cash inflows. Mario feels the two lathes are equally risky and the acceptance of either of them will not change the company's overall risk. He, therefore, decided to apply the company's 13% cost of capital when analysing the lathes. Norwich Tool requires all projects to have a maximum payback period of 4.0 years. Required: 2a. Research the concept of Payback period and calculate the Payback period of both lathes. 2b. Perform a cost benefit analysis and advise Mario which lathe to acquire. Do support your assumptions for including any item or variable. (tip: a point listed or an element description is given only one (1) mark)
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