Question

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)

Answer 1

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