Garrett Boone, Farish Enterprises’ vice president of operations, needs to replac

Question

Garrett Boone, Farish Enterprises’ vice president of operations, needs to replace an automatic lathe on the production line. The model he is considering has a sales price of $364,900 and will last for 11 years. It will have no salvage value at the end of its useful life. Garrett estimates the new lathe will reduce raw materials scrap by $42,200 per year. He also believes the lathe will reduce energy costs by $23,750 per year. If he purchases the new lathe, he will be able to sell the old lathe for $5,294. Click here to view the factor table.

(a) Calculate the lathe’s internal rate of return.

(b) If Farish Enterprises uses a 11% hurdle rate, should Garrett purchase the lathe?

Explanation / Answer

Ans a IRR is the rate where NPV is 0 We will do this by trial and error, at 11% it has positive NPV of $49714, so we have to increase this rate upto say we take 15%, it is negative lets take a less percent 14% Year Cash Flow Discount Factor 15% Discounted cash Flow Discount Factor 14% Discounted cash Flow 0 -364900 1 -364900 1 -364900 0 5294 1 5294 1 5294 1 65950 0.8696 57348 0.8772 57850.88 2 65950 0.7561 49868 0.7695 50746.38 3 65950 0.6575 43363 0.6750 44514.37 4 65950 0.5718 37707 0.5921 39047.69 5 65950 0.4972 32789 0.5194 34252.36 6 65950 0.4323 28512 0.4556 30045.93 7 65950 0.3759 24793 0.3996 26356.08 8 65950 0.3269 21559 0.3506 23119.37 9 65950 0.2843 18747 0.3075 20280.15 10 65950 0.2472 16302 0.2697 17789.6 11 65950 0.2149 14176 0.2366 15604.92 NPV -14443 NPV 2 so NPV is just $2 very close to 0 so IRR=14% Ans a Ans B For purchase of the option we have to calculate NPV, if NPV is positive than we can purchase Year Cash Flow Discount Factor 11% Discounted cash Flow 0 -364900 1 -364900 0 5294 1 5294 1 65950 0.9009 59414 2 65950 0.8116 53526 3 65950 0.7312 48222 4 65950 0.6587 43443 5 65950 0.5935 39138 6 65950 0.5346 35260 7 65950 0.4817 31765 8 65950 0.4339 28617 9 65950 0.3909 25781 10 65950 0.3522 23227 11 65950 0.3173 20925 NPV 49714 Yes the new lathe is having positive NPV so we can buy new lathe

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