Balakong Tools & Machine Shop is considering replacing one of its lathe machines with either of...

 

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Balakong Tools & Machine Shop is considering replacing one of its lathe machines 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, Mr. Choo Kam Seng, a financial analyst, prepared estimates of the initial investment and relevant cash inflows associated with each lathe. These are shown in the following table. Initial investment, (CFO) Year Lathe A $580,000 Cash inflows (CFt) 130,000 80,000 150,000 110,000 170,000 96,000 160,000 90,000 400,000 200,000 Note that Mr. Choo 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. Lathe B $380,000 1 2 3 4 5 Mr. Choo believes that the two lathes are equally 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 analysing the lathes. Balakong Tools requires all projects to have a maximum payback period of 4.0 years. a) Use the payback period to assess the acceptability and relative ranking of each lathe. (3 marks) b) Assuming equal risk, use the following sophisticated capital budgeting techniques to assess the acceptability and relative ranking of each lathe: (1) Net present value (NPV). (2) Internal rate of return (IRR). (4 marks) (4 marks) c) Summarize the preferences indicated by the techniques used in parts (a) and (b). Do the projects have conflicting rankings? Recommend which lathe should be chosen. (1 marks) [Total: 12 marks] N.B. - Round to two decimal places. Balakong Tools & Machine Shop is considering replacing one of its lathe machines 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, Mr. Choo Kam Seng, a financial analyst, prepared estimates of the initial investment and relevant cash inflows associated with each lathe. These are shown in the following table. Initial investment, (CFO) Year Lathe A $580,000 Cash inflows (CFt) 130,000 80,000 150,000 110,000 170,000 96,000 160,000 90,000 400,000 200,000 Note that Mr. Choo 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. Lathe B $380,000 1 2 3 4 5 Mr. Choo believes that the two lathes are equally 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 analysing the lathes. Balakong Tools requires all projects to have a maximum payback period of 4.0 years. a) Use the payback period to assess the acceptability and relative ranking of each lathe. (3 marks) b) Assuming equal risk, use the following sophisticated capital budgeting techniques to assess the acceptability and relative ranking of each lathe: (1) Net present value (NPV). (2) Internal rate of return (IRR). (4 marks) (4 marks) c) Summarize the preferences indicated by the techniques used in parts (a) and (b). Do the projects have conflicting rankings? Recommend which lathe should be chosen. (1 marks) [Total: 12 marks] N.B. - Round to two decimal places.

Answer rating: 100% (QA)

a To assess the acceptability and relative ranking of each lathe using the payback period we need to calculate the payback period for each lathe and compare them to the maximum allowed payback period ... View the full answer