ABC 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, a financial analyst, prepare estimates of the initial investment and incremental (relevant) cash inflows associated with each lathe. These are given below:

t	0	1	2	3	4	5
Lathe A	-660,000	128,000	182,000	166,000	168,000	450,000
Lathe B	-360,000	88,000	120,000	96,000	86,000	207,000

Your task is 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 fifth-year cash inflows. One of ABCs major dilemmas centered on the risk of the two lathes. The financial analyst feels that although the two lathes have similar risk, Lathe A has a much higher chance of breakdown and repair due to its sophisticated and not fully proven solid-state electronic technology. Because the financial analyst is unable to effectively quantify this possibility. You are asked to apply the firms, 13 percent cost of capital when analyzing the lathes. ABC requires all projects to have a maximum payback period of 4 years.

a. Use the payback period to assess the acceptability and relative ranking of each lathe. b. Assuming equal risk, use the following 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 a and b, and indicate which lathe you recommend assuming that the projects are (1) independent (2) mutually exclusive.