Garrett Boone, Farish Enterprises\' vice president of operations, needs to repla

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 $262,200 and will last for 6 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 $42,800 per year. He also believes the lathe will reduce energy costs by $23,250 per year. If he purchases the new lathe, he will be able to sell the old lathe for $5,351. (a) Calculate the lathe's internal rate of return. (b) If Farish Enterprises uses a 12% hurdle rate, should Garrett purchase the lathe?

Explanation / Answer

Statement showing Cash flows Particulars Time PVf@12% Amount PV Cash Outflows                               -                          1.00                       (262,200.00)                       (262,200.00) PV of Cash outflows                       (262,200.00) Cash inflows = 42,800+ 23,250                          1.00                   0.8929                           66,050.00                           58,973.21 Cash inflows = 42,800+ 23,250                          2.00                   0.7972                           66,050.00                           52,654.66 Cash inflows = 42,800+ 23,250                          3.00                   0.7118                           66,050.00                           47,013.09 Cash inflows = 42,800+ 23,250                          4.00                   0.6355                           66,050.00                           41,975.97 Cash inflows = 42,800+ 23,250                          5.00                   0.5674                           66,050.00                           37,478.54 Cash inflows = 42,800+ 23,250                          6.00                   0.5066                           66,050.00                           33,462.99 Cash inflows = Salvage Value                               -                     1.0000                              5,351.00                              5,351.00 PV of Cash Inflows                         276,909.45 NPV                           14,709.45 Statement showing Cash flows Particulars Time PVf@14% Amount PV Cash Outflows                               -                          1.00                       (262,200.00)                       (262,200.00) PV of Cash outflows                       (262,200.00) Cash inflows = 42,800+ 23,250                          1.00                   0.8772                           66,050.00                           57,938.60 Cash inflows = 42,800+ 23,250                          2.00                   0.7695                           66,050.00                           50,823.33 Cash inflows = 42,800+ 23,250                          3.00                   0.6750                           66,050.00                           44,581.87 Cash inflows = 42,800+ 23,250                          4.00                   0.5921                           66,050.00                           39,106.90 Cash inflows = 42,800+ 23,250                          5.00                   0.5194                           66,050.00                           34,304.30 Cash inflows = 42,800+ 23,250                          6.00                   0.4556                           66,050.00                           30,091.49 Cash inflows = Salvage Value                               -                     1.0000                              5,351.00                              5,351.00 PV of Cash Inflows                         262,197.49 NPV                                    (2.51) a) IRR = 14% Approx b) Yes Farish Enterprises should purchase lathe machine since IRR is14% which is higher than hurdle rate of 12%. Also NPV is positive at 12%

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