Question

Making Norwich Tool's Lathe Investment 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 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. (Click on the icon located on the top-right corner of the data table below in order to copy its content into a spreadsheet.) Lathe A Lathe B Initial investment (CF) $660,000 $360,000 Year (t) Cash inflows (CF) $88.000 $128.000

Answer 1

the investment decision should be based on internal rate of return because market interest rate or discount rate is not given.

let R represents rate of return in percent

therefore CF₀ = CF₁/(1 + R) + CF₂/(1 + R)^2 + CF₃/(1 + R)^3 +  CF₄​​​​​​​/(1 + R)^4 + CF₅​​​​​​​/(1 + R)^5

for Lathe A

660000 = 128000/(1 + R) + 182000/(1 + R)^2 + 166000/(1 + R)^3 + 168000/(1 + R)^4 + 450000/(1 + R)^5

hence R_A = 15.945%

for Lathe B

360000 = 88000/(1 + R) + 120000/(1 + R)^2 + 96000/(1 + R)^3 + 86000/(1 + R)^4 + 207000/(1 + R)^5

hence R_B = 17.339%

since rate of return R_B is greater hence investing in lathe B is best option