URGENT
Making Norwich Tool's Lathe lnvestment Decision 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 analyze these allernatives, Mario Jackson, a financial analyst, prepared estimates of the initial investment and incremental (relevant) cash intows assoclated with each lathe. These are shown in the following table. (Click on the icon here D in order to copy the contents of the data table below into a speadsheet) Note that Mario plans to analyze both lathes over a 5-year period. At the end of that time, the lathes would be sold, thus accounting for the large fith-year cash infliows. Mario believes that the two lathes are equaly risky and that the acceptance of either of them will not change the firm's overall risk. He therefore decides to apply the firm's 13.0% cost of capital when analyzing the lathes. Norwich Tool requires all projects to have a maximum payback period of 4.0 years. To Do a. Use the payback period to assess the acceptablity and relative ranking of each lathe. b. Assuming equal risk, use the following sophisticated capital budgeting techriques to assess the acceptability and relative ranking of each lathe: (1) Net present value (NPV). (2) internal rate of rebum (IRR) c. Summarize the prelerences 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 coserved confict in terms of the relative ditferences in the magnitude and timing of each project's cash flows. e. Use your findings in parts a through d to indicale, on both (1) a theoretical basis and (2) a practical basis, which lathe would be prelerred. Explain any diflerence in recommendations. is prelerred over based on the IRR. However, as can be seen in the NPV profile, to the left of the cross-over point of the two ines is preferred. The underlying cause of this conflict in rankings arises from the reinvestment assumption of NPV versus IRR. NPV assumes the intermediate cash flows are reinvested at the cost of capital, while the IRR has cash flows being reirvested at the IRR. The difference in these two rates and the timing of the cash flows will determine the cross-over point. e. Use your findings in pars 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. (Seiect from the drop-down menus.) On a theoretical besis should be prefered because of its higher NPV and thus its known impact on shareholder weath. From a practical perspective. higher IRR and its faster payback. This difference results from managers preference for evaluating decisions based on percent retums rather than dollar returs, and on the desire to get a retum of cash flows as quickly as possible. c. Summarize the preferences indicated by the sechriques used in parts (a) and (b). Do the projects have conflicting rankings? (Select all the choices that apply.) A. Both projects have positive NPVs and IRRs above the firm's cost of capital. Lathe A, however, exceeds the maximum payback period requirement. Because it is so close to the 4-year maximum and this is an unsophisticated capital budgoting technique, Lathe A should not be eliminated from consideration on this basis alone, particularly since it has a much higher NPV. B. If the firm has unlimited funds, it should choose the project with the highest NPV, Lathe A, in order to maximize shareholder value. C. If the firm has unaimited funds, is should choose the project with the highest NPV, Lathe B, in order to maximize shareholder value. D. If the firm is subject to capital rationing, Lathe B, with ts shorter paybeck period and higher IRR, should be chosen. The IRR considers the relative size of the investment, which is important in a capital rationing situation. d. Draw the net present value profies for both projects on the same set of axes, and dacuss any conflet in rankings that may exist between NPV and ifR. Explain any observed confict in terms of the relative dillerences in the magnitude and timing of each propecrs cash flows. To creale an NPV profie in is best to have at least 3 NPV data points. To create the third point an 8.0% discount rate was arbitrarly chosen. The graph that depicts the NPV profile for this problem is (Salect from the drop-down menu.) a. Use the payback period to assess the acceptablity and relative ranking of each lathe. The payback period for lathe A will be years. (Round to two decimal phaces.) The peyback peried for lathe B will be years. (Round to two decimal places.) (Solect from the drop-down menus.) will be rejected since the payback is longer than the 4ryear maximum accepted, and is accepted because the project paytack period is less than the 4-year payback cultoff. b. Assuming equal risk, use the following sophisticated capital budgeting techniques to assess the acceptabilify and relative ranking of each lathe: (1) Net present value (NPV) The net present value for lathe A is $ (Round to the nearest cent.) The net present value for lathe B is S (Round to the nearest cent.) (2) intermal rate of retum (IRR) The internal rate of return of inthe A is %. (Round to two decintal places.) The internal rate of return of lathe B is K. (Round to two decinsal places.) (Select trom the drop-down menus,) Under the NPV rule both lathes are acceptable since the NPVs for A and B are greater than zero. since it has a larger NPV. The same accept decision applies to both projects with the IRR, since both IRRS are greater than the 13.0% cost of capeal. However, the ranking reverses under the IRR nule because the 17.34% IRR for is greater than the 15.95% IPR for c. Summarize the preferences indicated by the techriques used in parts (a) and (b). Do the projects have conficting fankings? [Select all the choices that apply)
