81176461 Norwich Tools Lathe Investment Decisions

CASE: MAKING NORWICH TOOLS LATHE INVESTMENT DECISIONS
PAR T A:
PAYBACK PERIOD

ACCEPTABILTY OF EACH PROJECT:
Lathe A will be rejected because it’s payback period is longer than 4 years maximum expected payback period
4.04years > 4years
Lathe B project is accepted because it payback period is less than the 4 year maximum payback period
3.65years < 4 years

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PART B:
NPV &IRR

LATHE A NPV & IRR
LATHE B NPV & IRR years cash flow
PV Factor @13%
PV
cash flows
PV Factor @13%
PV
0
(660,000)
1
(660,000)
(360,000)
1
(360,000)
1
128,000
0.885
113,274
88,000
0.885
77,876
2
182,000
0.783
142,533
120,000
0.783
93,978
3
166,000
0.693
115,046
96,000
0.693
66,533
4
168,000
0.613
103,038
86,000
0.613
52,745
5
450,000
0.543
244,242
207,000
0.543
112,351

NPVA
58,133

NPVB
43,483

IRRA
16%

IRRB
17%

ACCEPTABILTY OF EACH PROJECT:

Under the NPV calculations both projects are acceptable because NPV of both project is positive or we can say greater than zero.
NPV LATHE A: 58,133 > 0
NPV LATHE B: 43,483 > 0
Lathe A has a larger NPV than B so it is preferable.
IRRs of both projects are greater than the 13% cost of capital so both project are acceptable. However, 17% IRR for B is greater than the 16% IRR for lathe A so it is B is preferable.

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PART 3:
SUMMARY:

LATHE A
LATHE B
PBP
4.04 years
3.65 years
NPV
58,133
43,483
IRR
16%
17%

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 budgeting technique, Lathe A should not be eliminated from consideration on this basis alone, particularly since it has a much higher NPV.
If the firm has unlimited funds, it should choose the project with the highest NPV, Lathe A, in order to maximize shareholder value. If the firm is