Question

In: Finance

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine...

Vandalay Industries is considering the purchase of a new machine for the production of latex. Machine A costs $3,048,000 and will last for six years. Variable costs are 40 percent of sales, and fixed costs are $195,000 per year. Machine B costs $5,229,000 and will last for nine years. Variable costs for this machine are 35 percent of sales and fixed costs are $130,000 per year. The sales for each machine will be $10.1 million per year. The required return is 11 percent, and the tax rate is 30 percent. Both machines will be depreciated on a straight-line basis. The company plans to replace the machine when it wears out on a perpetual basis.

Calculate the NPV for each machine. (A negative answer should be indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
  

NPV
Machine A $
Machine B $


Calculate the EAC for each machine. (Your answers should be a negative value and indicated by a minus sign. Do not round intermediate calculations and round your answers to 2 decimal places, e.g., 32.16.)
  

EAC
Machine A $
Machine B $


Which machine should the company choose?
  

Machine A

Machine B

THESE ARE NOT THE ANSWERS:

NPV MachineA (14,965,207.13) MachineB (20,677,737.99)

EAC MachineA (-3,537,424.23) MachineB (-3,734,433.90)

Solutions

Expert Solution

I. Calculation of NPV for each machine.

- Machine A

Year Cashflow Depreciation (De) PBT Tax@30% PAT (PBT-Tax) CFAT(PAT+De) PVF/PVAF@11% CFAT*PVF
0        (3,048,000)                                  -                           -                           -                           -           (3,048,000) 1        (3,048,000.00)
1-6          5,865,000                      508,000          5,357,000          1,607,100          3,749,900           4,257,900 4.2310        18,015,174.90

Net Present Value = PV of Inflows - PV of Outflows

= 18,015,174.90 - 3,048,000

= 14,967,174.90

Cashflow per Year = Sles - Variable cost - fixed costs = (10100000*.6)-195000 = 5,865,000

Depreciation per Year = Cost/Useful life = 3,048,000/6 = 508,000

PBT = Cashflow - Depreciation

PVAF = (1-(1+r)^-n)/r = (1-1.11^-6) / .11= 4.231

- Machine B

Year Cashflow Depreciation (De) PBT Tax@30% PAT (PBT-Tax) CFAT(PAT+De) PVF/PVAF@11% Cashflow*PVF
0        (5,229,000)                                  -                           -                           -                           -           (5,229,000) 1        (5,229,000.00)
1-9          6,435,000                      581,000          5,854,000          1,756,200          4,097,800           4,678,800 5.5370        25,906,515.60

Net Present Value = PV of Inflows - PV of Outflows

= 25,906,515.60-5,229,000

= 20,677,515.60

Cashflow per Year = Sles - Variable cost - fixed costs = (10100000*.65)-130000 = 6,435,000

Depreciation per Year = Cost/Useful life = 5229000/9 = 581,000

PBT = Cashflow - Depreciation

PVAF = (1-(1+r)^-n)/r = (1-1.11^-9) / .11= 5.537

II. Calculation of EAC for each machine.

Machine A Machine B
a Purchase Cost ($)      (3,048,000.00)      (5,229,000.00)
b Life of machines (years)                         6.00                         9.00
c Running cost per year ($)      (4,235,000.00)      (3,665,000.00)
d PVAF (based on life and 11% discount factor)                      4.231                      5.537
e Present Value of Running cost of machine (c*d) (17,918,285.00) (20,293,105.00)
f Cash outflow of machines (a+e) (20,966,285.00) (25,522,105.00)
g Equivalent Annual Cost (f/d)      (4,955,397.07)      (4,609,374.21)

III. Which machine should the company choose?

Based on NPV machine B is preferable, since it has higher NPV

BAsed on EAC also machine B is preferable, since it has lower EAC


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